How America Spends: A Macroeconomic Inflation Model

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Inflation is literally the equivalent of having your shares in a company diluted. If you own a stake in a company and they issue 20% more shares with no compensatory value to the original shareholders, you instantly lose 20% of your value in said company.

Inflation does the same with the purchasing power of a currency: It devalues the currency by the amount of the new issuance.

Our model, How America Spends, has been tracking the purchasing behavior of 135 million U.S. households since 2014. This model is not a black box – it is a data file representing the spending of 135 million households on goods and services since 2014. The households are stratified into nine income categories, enabling us to identify how inflation has impacted low- and middle-income households, while also observing any changes within upper income families.

In Q1 of 2022, while we were reading everywhere that inflation was contained, our model was showing the mix of goods and services purchased by median households was up 14%, year over year. Six months later, we were all being told that inflation was ‘transitory,’ while our model was showing it at 12%.

Why does this matter? Households were quickly becoming poorer and taking on debt to meet expenses. This was absolutely going to affect businesses.

Your client portfolios depend on accurate and comprehensive information in order to maximize returns while minimizing risk. A blind spot exists in many portfolios, however, as investors have been operating under the false assumption that inflation has impacted only lower income households. Additionally, there is broad consensus that as inflation has retreated, its effects are in the rearview mirror. These assumptions are incorrect. In this article, I will show you the totality of the effects of inflation on consumers and how this might impact your investment decisions going forward.

To begin, inflation has materially altered the consumption patterns of two-thirds of households since it took root early on in the COVID-19 pandemic. And 46% of all households are now deficit spending each month in order to maintain access to food, energy and shelter. This is impacting many consumer-facing businesses, to the extent that it has bankrupted some publicly traded companies, while significantly reducing the earnings and share prices of many others.

What inflation actually does to a household

Here is the behavioral pattern of the median household as inflation alters its consumption. I overlay this on a timeline of the past five years:

January 2020 (pre-COVID-19) – The family has entrenched consumption patterns for nondiscretionary items (food, energy, shelter, healthcare, education) and relatively stable consumption behavior of discretionary purchases, which include entertainment, sporting activities, vacation and the like. The family likely has a mortgage and auto loan, and revolving debt rarely exceeds $2000.

January 2021 – The family’s lifestyle has of course been disrupted by COVID-19 lockdowns, but its finances are relatively strong, as members have not been able to make large discretionary purchases, such as a vacation. Many families have received government stipends to offset any hardship. At this point in time, cash balances for middle-income families are at an all-time high.

January 2022 – The family’s expenditures for nondiscretionary goods and services have risen by approximately 15% in two years. Expenditures for discretionary goods and services have risen by approximately 18% in this same time frame. At this point in time, cash balances for middle income families are at an all-time low.

January 2023 – The family has enjoyed the freedom to travel and taken a ‘once in a lifetime’ vacation. They are noticing inflation and have become more cost conscious when buying groceries, clothing, household items, and other goods and services. They have taken on more credit card debt than ever before.

January 2024 – The family has reduced its days of vacation from 14 days down to 10. They have reduced dining out from six times monthly, to two meals away from home. They have significantly reduced discretionary purchases and are ‘trading down’ on all categories of food and clothing. The family has continued to add to its credit card debt.

October 2024 – The trendline continues, with the family further cutting back on discretionary purchases, while their revolving debt rises. Worth noting, newly released college enrollment data shows full time enrollment at four-year colleges down from 2023 by 5%. The decline in enrollments is deepest among low- and middle-income families. The takeaway: Families are at the point of financial duress where they’re unable to invest in their children’s future.

It is important to note that as a household is impacted by inflation, it does not cut spending. In fact, it increases spending in order to maintain the standard of living to which it has become accustomed. The spending increase is of course in nominal terms (with devalued dollars) and is facilitated by reducing savings and, later, by taking on debt.

As a household is impacted by inflation, it typically utilizes debt to maintain the consumption patterns to which it is accustomed. As debt service becomes onerous, the household begins altering its consumption by substituting or foregoing certain goods and services.

46% of households are now deficit spending, and that number has been rising by 5% annually. Our data provides clarity as to how evolving consumer purchasing is impacting business activity by:

Showing the earnings and spending patterns for 135 million US households;
Tracking 10 years of expenditures to illustrate the evolution of spending patterns;
Revealing drivers of business decline/growth by consumer spending behavior; and
Providing a perspective and level of detail that enables the development of reliable forward-looking projections.

Inflation’s effects on households across the income strata

The following three graphs demonstrate how consumer consumption patterns remain relatively constant in periods of low inflation (2014 to 2020). However, once inflation rises, low- and middle-income households substitute higher-cost goods for lower-cost goods.

Households have cut back substantially on higher cost food items and apparel.

Middle-income households have made moderate adjustments to their purchasing behavior.

Middle-upper-income households make minimal adjustments to their purchasing behavior.

Drilling down

These next few tables will enable you to visualize clearly how consumption changes over time, by income class. Note that in this article, I show examples of the available data. All files are available with actual values from 2014 through 2023, and estimates of 2024 and 2025.

Table 1: Income and expenditures, non-discretionary and discretionary

Note the highlighted area showing the extent of deficit spending, and the increasing number of households engaged in deficit spending.

An example of actionable investment insights

Investors were caught off guard by the bankruptcies of restaurant chains (including Red Lobster) serving middle-income consumers. This was because of the narrative that inflation affected only the low-income consumer and that the effects of inflation on the broader economy would be minimal. Although it is true that the low-income consumer has been most severely affected by inflation, middle-income consumers have also adjusted their budgets and are substituting higher-cost items for lower-costs goods when possible.

However, when we reviewed the rise of dollars allocated to ‘food at home’ over series of years, and the corresponding decline in dollars allocated to ‘food away from home’ over the same years, it was evident that the restaurants with exposure to low- and middle-income consumers were seeing a decline in revenues.

Table 2: Food purchased for consumption at home – reference year 2022

Table 3: Food purchased for consumption away from home – reference year 2022

Households in the low- and middle-income categories had less residual income for dining out, which made the restaurant consolidation predictable.

Table 4: Discretionary purchases – reference year 2022

Discretionary consumption remained flat.

Understanding how it is possible for a household to spend two and three times their annual income requires a comprehensive view of their finances. Lower-income households receive, on average, a few thousand dollars annually in social assistance payments. Many have sources of ‘off the books income,’ and while difficult to pinpoint the amounts, it does exist. And lastly, credit card debt is a major source of access to capital. It should surprise no one that consumer credit card debt is at an all-time high.

Interest expenditures – reference year 2023

Without significant increases in deficit spending, discretionary consumption declined. It is important to note that 70% of households have taken on significant credit card debt since 2022.

In essence, businesses have to determine how to move forward with two thirds of households having reduced purchasing power. For the investor trying to ascertain who the winners and losers will be, it’s probably not wise to rely on the narrative of ‘a strong labor market means a strong consumer,’ as the BLS has revised down its employment numbers for 14 of the last 15 months. If the economy is truly strong, the federal government shouldn’t need to add $2 trillion annually in deficit spending to generate positive GDP numbers.

‘Consumer spending is strong’

Of course it is; two thirds of consumers are spending every penny of their earnings to put food on the table. 38% of households have at least one maxed-out credit card. The ten-year average is 15%. Regardless of the spin being put on rising consumer spending, it is in no way indicative of a healthy or strong economy. Prices have risen to the extent that consumers are deficit spending in order to meet their needs for everyday essentials – period. The bottom line of this calculus is actually quite simple: Consumer spending is rising in exactly the same manner that GDP is positive. This is all debt financed.

The next six months….

Based on our model, I believe strongly that this holiday shopping season will be the last for more businesses than ever. Corporate bankruptcies are already up 35% year-over-year. Retail and hospitality operations will be especially challenged. In terms of purchasing power and debt, the consumer has never been in worse shape. That is a worst-case scenario for businesses in retail and hospitality. I know this as I have been observing the changes in purchasing behavior for a decade.

Businesses will push on to make it through the holidays, pay what bills they can, and then evaluate their viability going forward. Thus far, our model has been directionally spot-on regarding the sectors that would take a hit. And the magnitude of the hit has been within a very reliable range. The annual average failure rate of all businesses over 20 years ranges from 8% to 9%, with the exception of 10% in 2010. We’re at 10% now, and our model is projecting north of 13% in Q2 of 2025.

Paul Hill is the cofounder of Educate To Career (ETC). ETC is a nonprofit, specializing in providing college planning programs and data to over 1,000,000 families, financial advisors, and campus career centers each year. The firm is the leading vendor of actuarial analysis of college outcomes data to student lenders. Their charter is to help young people get an affordable education, leading to a real job, with no student debt.

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