An increase in the Federal Reserve’s preferred measure of inflation is cancelling out December’s modest rise in personal income and pointing to growing financial strain for lower and middle income households.
Personal consumption expenditure (PCE) inflation increased 0.4% in December, up from a 0.2% increase in November and 3.0% over the past year, according to the U.S. Bureau of Economic Analysis data out Friday. The December increase caps the fifth consecutive year of inflation above the Federal Reserve’s 2% target. Meanwhile, real disposable personal income — personal income after taxes and adjusted for inflation — essentially flatlined in December.
Friday’s personal income and outlays report indicates that inflation continues to stunt real purchasing power, underscoring what many economists are calling a K-shaped economy — one defined by a widening divide between higher and lower-income households. Rising prices hit middle and lower-income earners hardest, as they devote a larger share of their paychecks to essentials like food, energy and rent, which have seen some of the steepest increases. Meanwhile, higher-income households have been better insulated by rising stock market wealth and asset gains.
“The fulcrum point of the K has shifted higher from a lower case ‘k’ to an uppercase ‘K’,” noted Tom Simons, senior economist at Money Market Jeffries LLC, who pointed to the growing divide in real disposable personal income between high and lower income earners.
Chart: Federal Reserve Bank of St. Louis
Most of December’s personal income growth was fueled by transfer payments such as Social Security, Medicare, and Medicaid, which made up 19.2% of total personal income for the month, a near historic high. Transfer payments disproportionately benefit retirees and lower-income households, leaving many middle-class earners, who tend to rely primarily on wages, more exposed to rising prices and sluggish income growth.
To add to the strain, the saving rate for December continued its downward trajectory from 3.7% in November towards a significantly low 3.6% in December, suggesting Americans are saving less or even dipping into their savings as prices increase and erode purchasing power. A dropping savings rate is most concerning for lower income households because they may be inching closer and closer to a point where they begin to cut back on spending.
December’s BEA report was initially scheduled to be released last month but was postponed due to last year’s prolonged government shutdown. At last month’s Federal Open Market Committee meeting, members noted how the shutdown may have led to an underestimation of November and December’s PCE price index, which could mean inflation was even higher than reported.
The year ahead may also bring higher service inflation as the immigration crackdown shrinks the labor force leading to higher wages and an increased cost of services. However, Simons believes inflation will continue its slow descent towards the Fed’s target.
“Inflation has limited room to run in an environment where so many households are struggling to keep up with price increases,” he said, suggesting prices for consumer goods and services can only rise so high before demand begins to drop. “You can’t get blood from a stone.”
