A falloff in consumer confidence in May is due to surging inflation that consumers anticipate will persist in the year ahead, according to the University of Michigan Surveys of Consumers.

Record proportions of consumers reported higher prices across a wide range of discretionary purchases, including homes, vehicles and household durables. The impact of higher prices on discretionary spending will be offset by the more than $2 trillion increase in savings in the past year as well as by improving job and wage prospects, says U-M economist Richard Curtin, director of the surveys.

While higher inflation will diminish real incomes, the data still indicate an exceptionally robust outlook for consumer spending through mid-2022, he says.

“While the growth of an inflationary psychology is unlikely, it cannot be entirely dismissed,” Curtin said. “Early preventative actions are much less costly, such as by hinting of a small rate hike; this could easily douse an incipient inflationary psychology. Indeed, two-thirds of consumers already expect higher interest rates. Higher inflation and higher unemployment each have uneven impacts across the population.

“While stable prices have had too much emphasis over full employment in the past, it is an unrealistic goal of monetary policy to achieve macro growth as well as micro distributional targets. Fiscal policies must share in the burden not just the glory.”

Widespread awareness of rising prices
Buying plans were curtailed by a substantial increase in complaints about current prices for homes, vehicles and household durables, Curtin says. The month-to-month change in references to high prices was at an all-time high in May, with highest mentions of high prices for homes since the 1950s and for vehicle and household durable prices since the early 1980s.

Consumers anticipated the overall inflation rate to be 4.6% in the year ahead, with twice as many consumers expecting an inflation rate of 5% or higher rather than 2% or below (44% vs. 22%). Among all homeowners, 80% reported recent gains in the value of their homes, the highest level since the early 1990s, and expected the year-ahead increase to be 4.8% in May, up from last month’s 3.2% and January’s 0.5.

Resurgent economy adds jobs
Job gains partially offset concerns about inflation, with an all-time record 54% expecting a lower unemployment rate during the year ahead. Consumers reported their awareness of the recent jobs slowdown, but on balance still reported more news of continuing gains than losses, Curtin says.

Consumers were five times more likely to report improved economic conditions in May than in January, and the majority of consumers anticipated the reestablishment of good times in the economy as a whole during the year ahead. Long-term prospects for the national economy remained largely unchanged, with the balance tilting slightly toward a renewed downturn in the next five years.

Consumer Sentiment Index
The Consumer Sentiment Index fell to 82.9 in the May 2021 survey from 88.3 in April, although it remained well above last May’s 72.3. The Expectations component fell to 78.8 in May from 82.7 in April, but was well above last year’s 65.9. The Current Conditions Index fell to 89.4 in May 2021 from 97.2 in April, but remained ahead of last May’s 82.3.

Consumer confidence remained largely unchanged at the reduced level recorded at mid-month. It is hardly surprising that the resurgent strength of the economy produced more immediate gains in demand than supply, causing consumers to expect a surge in inflation. Record proportions of consumers reported higher prices across a wide range of discretionary purchases, including homes, vehicles, and household durables - the average change in May vastly exceeds all prior monthly changes (see the chart). The impact of higher prices on discretionary spending will be offset by the more than $2 trillion increase in savings in the past year as well as by improving job prospects - an all-time peak proportion of consumers anticipated declines in the national unemployment rate during the year ahead. While higher inflation will diminish real incomes, the gains in spending will nonetheless be substantial. The key issue is whether the timing of spending decisions will advance due to the expected price increases. At present the growth in inflationary psychology is unlikely, but it cannot be completely dismissed. Early preventative actions are much less costly, but these actions are much more difficult when policy objectives include avoiding uneven distributional impacts across population subgroups. It will require keeping the level of stimulus higher for a longer period than would have seemed prudent in the past. The primary risk of this strategy is an accelerating inflation rate, which also has uneven distributional impacts. Shifting policy language and a small rate increase could douse inflationary psychology; it would be no surprise to consumers, as two-thirds already expect higher interest rates in the year ahead.