The public debate about inflation has caught on to what economists have long known: Price change—aka inflation—and prices are not the same thing. Though inflation has fallen back sharply over the last two years, prices have not dropped—they have merely risen more slowly. And while politicians promise lower prices on the campaign trail, the dirty little secret is that nobody wants prices to fall across the board. Falling prices constitute deflation, inflation’s ugly cousin.
So, are American voters stuck on a plateau of higher prices? Not quite. Wages matter just as much as prices. If the prices of all goods doubled in one year, consumers would face dire circumstances. But if wages also doubled, any financial injury would be largely psychological. What ultimately matters is price affordability—the ratio of prices and wages.
Price affordability in America
Since 2019, consumer prices are up nearly 20%, a painful surge after years of tame price growth in the pre-pandemic era. However, wages are up more than 25% over the same period. As a result, price affordability in aggregate is actually 5% better than it was in 2019.
At inflation’s crescendo in 2021-22, affordability slumped when wages did not keep pace. But since the middle of 2022, wages have been growing faster than prices. They’ve made up lost ground and are now inching ahead.
U.S. consumption data proves this point. While public discourse continues to paint U.S. consumers as cash-strapped and on the verge of folding, that narrative does not line up with the evidence. Total consumption has held up remarkably well despite gyrations in prices and wages, delivering strong growth and punting away persistent fears of recession. At an annualized pace of 2.9% in the second quarter, consumption is nowhere near recessionary conditions.
To reconcile the perception of consumer weakness with the fact of strong consumption we need to look inside consumers’ heads.
Consumers’ ability and willingness to spend are not the same but are often conflated. Today, the former remains quite strong, but after relentless price growth, the latter has become a matter of their perception of value for money.
The return of the $5 value meal in fast food restaurants is often touted as a sign of struggling consumers—but is it? During the pandemic, exploding grocery prices pushed consumers out of supermarkets and into fast-food restaurants where prices were rising more slowly. Over time, cumulative increases in fast-food prices eroded the relative value of dining out. Unsurprisingly, consumer demand has shifted back to groceries, where prices have leveled off. The return of the $5 value meal is a pitch to convince buyers to dine out again—offering value strategically where it once appeared organically.
Meanwhile, where value for money has been stable or improved, consumption has generally held up. Take toys and games, a sizable market worth $130 billion annually where consumers continue to spend liberally, and growth recently accelerated. The reason is that prices never grew substantially (5% at their peak) and resumed their fall when demand slowed. And it can’t be claimed that toys and games are the sole privilege of the rich, another popular narrative about US consumption. Unlike yachts, toys and games are consumed across the income distribution, even if the wealthy consume more.
Consumers perceive price rises and wage gains differently
Put simply, inflation is something bad that happens to us—a silent thief. But wage gains are something we earn, the fruits of our efforts. That asymmetry is ingrained in our thinking. And no increase in wages that was rightfully earned can offset the perceived injustice of higher sticker prices.
Additionally, the importance that consumers attach to specific items is often not reflected in dollars spent. For example, U.S. consumers spend roughly the same amount on chicken and computers (about 0.5% of income). Chicken has become far less affordable since 2019, as prices have risen over 30% compared to wage gains of 25%. Meanwhile, the affordability of computers has improved: Prices are down by 9%. Few consumers will offset loss and gain here. You’ll hear a lot more about the higher price of chicken than the lower price of computers.
Finally, it’s not just prices that move asymmetrically. There is also an underlying distribution of wage growth. While the average is 25% across all workers since 2019, many have received less—for example, workers in apparel manufacturing, whose wages have grown only 12% since 2019. Psychology aside, they don’t just feel like they’re falling behind, they actually have.
Over the past two years, the U.S. consumer has been misread and then misread again. Price change, price level, and price affordability are different things. Consumers’ willingness to spend is not tied tightly to ability. Though total numbers hide a vast range of experiences, at the end of the day, the macroeconomy is about the sum of its parts. Consumers are still spending, just not where we might be paying attention—or where they might prefer.
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