The effect of inflation on American households

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Credit Sesame discusses the effect of inflation on American households from 2022 to 2023.

By some measures, the American economy had a decent year last year. The economy grew, as did employment. So why do so many households feel they took a step back? A new survey by the Federal Reserve found that American households felt worse off financially than they had a year earlier. The key factor seems to be inflation. The survey reveals several ways that inflation has impacted American families.

Sense of financial well-being doesn’t match economic data

In 2022, U.S. Gross Domestic Product (GDP) grew by 2.1% after adjustment for inflation. GDP is a broad measure of overall economic activity. 2.1% is a fairly modest pace of growth, but any time GDP grows faster than inflation it means the economy is making progress.

Job growth had an especially strong year in 2022, with the addition of nearly 4.8 million jobs. As a result, the unemployment rate spent most of the year near its lowest level since the 1950s.

You might think that economic growth and a strong job market would make consumers feel better off, but the Fed survey found a more somber mood. While 73% of adults said they were doing at least okay financially last year, that number represents a 5% drop from the previous year’s survey. 

The decline in household finances is shown especially by the percentage who said they were worse off than a year earlier. This share of respondents rose to 35%, a 15% increase from the year before. Those numbers are both even worse than the figures from 2020 when much of the economy had to shut down because of the onset of the pandemic.

More people report getting a raise or promotion

Under normal circumstances, getting a raise or a promotion makes people feel as though they’re getting ahead. In those terms, 2022 was a better year than 2021. 33% of survey respondents reported getting a raise or a promotion last year. That’s better than the 30% from the previous year’s survey.

While it’s good that more people got a raise or a promotion last year, the fact remains that about two-thirds of respondents reported getting no such career advancement last year. In a year when inflation soared, having your income stand still means falling behind.

Spending rising faster than incomes

Last year the economy grew, the job market was very strong, and more people got raises and promotions than the year before. Yet despite all that, fewer people felt they were doing okay financially, and more people said they were worse off than a year earlier. This is likely due to the effect of inflation.

The year-over-year rise in the Consumer Price Index peaked at 8.9% last June 2022, the highest inflation rate since 1981. Though it has since eased somewhat, the inflation rate remains above its long-term average. 

Fast-rising prices have stretched many household budgets. 40% of respondents to the Fed’s survey said that their monthly spending increased last year, compared to just 33% who said their monthly income had risen. On average, private industry compensation rose by 5.1% in 2022, which didn’t keep up with the 6.4% rise in prices.

Prices rising faster than incomes helps explain why consumer debt is reaching record levels. Consumer debt has risen steadily over the past couple of years, reaching a new record high of $17.05 trillion in the first quarter of 2023.  

Expenses are pushing people closer to the edge

Rising expenses and debt levels are eroding the financial margin of safety for many households. As consumers struggle to make ends meet, they are spending their savings and setting aside less money for the future. 

Over a third of survey respondents would not have enough funds readily available to meet a $400 unexpected expense. The percentage of respondents who said they could readily cover a $400 financial emergency dropped by 5% last year, to 63%.

Having to borrow to handle a financial setback makes a bad situation worse by adding interest charges to unexpected costs. 

Another measure of emergency savings also dropped last year. The survey found that the number of respondents who said they had enough savings to cover 3 months worth of expenses dropped by 5%, falling to 54%. That means nearly half of American households could not withstand a job loss for an extended time. 

Even with a strong job market and the economy growing, the percentage of people who are able to pay their current bills fell last year. The survey found that only 82% of respondents said they could pay their current month’s bills, down from 86% the prior year. 

Today’s problems have a long-term impact

The financial crunch created by inflation is likely to have long-term consequences for many families. The survey found that just over half of the respondents say they have reduced their savings in response to higher prices. 

The issue of setting aside less money for the future was compounded by a bad year in the financial markets in 2022. This means that retirement assets took a hit. The survey found that 31% of workers felt their retirement plans were on track, down from 40% the year before. 

The irony is that high inflation makes it necessary to save more for retirement because future expenses are likely to be higher than originally expected. Instead, people reduced savings last year and saw their retirement investments take a step back.

How people are adjusting to the effect of inflation

The survey found that consumers are trying to adjust to inflation. Nearly two-thirds of those surveyed said they stopped or reduced their use of a product because of inflation. 64% substituted a cheaper product to save money. 

Besides tighter budgeting, workers should perhaps try to take maximum advantage of the strong labor market. 70% of respondents who asked for a raise last year got one. However, only 13% of respondents asked for a raise or promotion last year. 

With employers struggling to fill job openings, this may be a good time for workers to be more assertive about insisting that their pay at least keeps up with inflation.

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Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.

Richard Barrington
Financial analyst for Credit Sesame, Richard Barrington earned his Chartered Financial Analyst designation and worked for over thirty years in the financial industry. He graduated from St. John Fisher College and joined Manning & Napier Advisors. He worked his way up to become head of marketing and client service, an owner of the firm and a member of its governing executive committee. He left the investment business in 2006 to become a financial analyst and commentator with a focus on the impact of the economy on personal finances. In that role he has appeared on Fox Business News and NPR, and has been quoted by the Wall Street Journal, the New York Times, USA Today, CNBC and many other publications.

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