Introduction
The development of COVID-19 prompted unprecedented economic behaviors stemming from monetary policy (government debt monetization), fiscal policy (deficit spending), and general policy uncertainty. The United States’ Consumer Price Index (CPI) year-over-year increase was last reported at 8.5%, the highest jump since January 1982.
Although this sticker shock is being felt around the country, using the government measure of inflation from 1980, inflation is already the worst it has been since the inception of the CPI itself at a staggering 16.77%. Inflation has risen sharply and has flowed disproportionately in key areas: food, energy, transportation, housing, and general assets used as a hedge against this phenomenon.
However, there are generational differences in habits and expectations for these particular categories of spending that have not existed in prior inflationary periods. Our research focused on how these factors affected different age groups, particularly the college age individual (18–24 year old) in comparison with their older cohorts. Interestingly, the current polarization between how different generations has never been higher.
In this article, we sought to answer the research questions:
- Are young people’s expectations about pandemic-fueled inflation in line with reality?
- Are young people more complacent about inflation now than in the 1970s?
- How are young people currently being affected by inflation, and how is this likely to change in the coming years?
Methodology:
In order to gather data on the relationship different generations have with price expectations, we turned to the University of Michigan Consumer Sentiment Survey. This particular survey is seen as a benchmark for consumer sentiment across domestic financial markets and is seen as a bellwether for typical household outlooks.
Utilizing data from 1978–1980 and 2019–2022, we were able to compare these periods which experienced higher than normal levels of inflation. Consequently, we grouped the data into age cohorts, mainly the ages of 18–24 (college age) and 25–99 (everyone else) to analyze any differences or similarities in their economic understandings.
Key Findings:
- Price expectation differences have never been greater between college-age individuals and their older peers in any recent inflationary period. In the United States, the difference between the age cohorts 18–24 and 25 and older are in excess of 300%. This points to a monumental difference in how price expectations are experienced across all age groups.
- Young people are generally less educated about the economy and have less accurate expectations. Individuals aged 18–24 typically hold a more primitive economic understanding as compared with ages 25 and older. This is due in part to their lack of experience in real estate, dietary choices, and lack of formal education. Since young people are…young, they have less experience to draw on, even if they are making significant decisions like those pertaining to vehicles and housing.
- Due to inexperience, college-age individuals likely underestimate the extent of inflation in key areas of the economy, such as real estate. As few young people are buying homes, most have unrealistic expectations about pricing and purchase timelines. Since minimal savings coupled with home price expectations are well below the median, Generation Z is likely to rent housing longer than they currently believe.
- Rising energy costs have a lesser impact on the college-age budget compared with older ages as they encounter disproportionate energy consumption. Energy costs — specifically that of crude oil and natural gas — may account for 50% of the difference in generational inflation expectations, which have risen around 65% year-over-year. Lower car ownership rates, reduced consumption of transportation commodities, and an inverse relationship between food costs account for notable influences on energy consumption and their implications on budget forecasts.
- Gen Z is less affected by rising food costs due to an emerging conscious consumer mindset. Food costs are a major expense for college-age individuals, but with declining meat consumption and a waning propensity to purchase organic produce, Gen Z is experiencing less inflation than their older peers in certain categories.
- With declining real wages, Gen Z is likely to capitulate in their spending and economic outlook. While generations certainly experience inflation differently based on their job, diet, and spending choices, lower real wages will cause all generations to spend a greater amount on necessities and consumer-oriented products and services as compared to the recent credit-enabled expansion of consumer discretionary spending.
The Consumer Price Index
The Consumer Price Index (CPI) is a government measure of inflation based on a sample basket of goods and their associated prices over time. Since Basket Price Index Theory aims to estimate the spending of a typical citizen, some of the main categories that comprise the CPI are housing, transportation, food, education, medical care, and energy, among others.
Subjective Elements of CPI:
Over time, there have been numerous changes in the measurement of CPI with some of the most significant changes occurring throughout the 80s and late 90s after the CPI’s inception in 1919. These changes affect the way inflation is measured and reported to the public. The first major change is hedonics, which is a psychological branch that studies enjoyment and sensation. In the CPI, it is employed to measure quality and is ascribed to be a significant change due to its subjectivity. Secondarily, substitution — the idea that when steak becomes too costly, consumers will start buying chicken — is also another adjustment the government uses in its calculations. This is viewed by some as subjective due to the fluidity of the standard of living this creates. For example, over time, consumers may get priced out of eating steak, a food they enjoyed regularly before substantial inflation. The CPI would show this as a shift in consumer habits, even if they would prefer higher quality food but cannot afford it.
One of the most critical components of the CPI, Owners Equivalent Rent (OER), is particularly important because of its weight, which is currently at 32.56%. OER is based on the Consumer Expenditure Survey (CES) and is aggregated based on the question, “If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished, and without utilities?” Given the ambiguity and the perceived vested interest of homeowners in artificially lowering the fair market rental value of their property, there is room for massive error and understatement in an item that currently makes up nearly a third of the weight in the current CPI. While the government does include renter data to a degree, any change in weighting using the alteration of equivalent rents vastly changes the output of CPI.
Generational Differences in Pricing Expectations
The price expectation difference between college-age individuals and their older cohorts compared to the CPI in 2018–2022 is currently 318% larger than it was during 1978–1980. During the period between 1978 and 1980, the college-age individual expected prices to increase by 10.821% while everyone older than this cohort expected an average change of 12.265% which signals a difference of 1.444%. This may seem insignificant since it is similar to the current delta (3.406), but when measured by its difference from the time period’s CPI, it tells another story. The difference between both age groups divided by the CPI shows a 13.57% in 1980 and a 43.27% in 2022.
While the data subset is smaller than the 25-year-old and above cohort (as seen in its volatility), the fact remains that younger individuals experience and expect price changes in a different way than older groups. Some of the main contributing factors of why this relationship exists is because of real estate, energy, food choices, and real earnings.
Real Estate Prices
With mortgage rates depending heavily upon inflation outlooks, real estate serves as a key factor contributing to inflationary expectations. Gen Z’s inexperience in the real estate market is attributed to lower saving rates and a growing median home buyer age. This results in unrealistic expectations for purchasing a home and, therefore, an inaccurate perception of real inflation in the economy.
The median age of home buyers has steadily increased from the middle 30s in 1981 to over 45 in 2019, meaning that Gen Z will likely prepare to purchase a home at a later age when compared to their generational counterparts. In addition to holding the lowest ownership rates, a June 2021 survey found that Gen Z expects to pay $233,468 for a home while the actual US median sales price of a home was $363,300. This 38% difference can misguide the 86.2% of Gen Z seeking to purchase a home. Gen Z underestimates the cost of a home as 40.3% of those surveyed attribute their challenges to purchasing a home to insufficient savings and home prices. In reality, Gen Z only represents about 2% of buyers and sellers with 82% of ages 22–30 stating that they are first-time home buyers.
Clearly, younger people expect to pay substantially less than the median price of a house. Furthermore, this median price level could increase as raw materials used to build homes have seen considerable effects of inflation, resulting in an increased cost to build and a higher replacement cost of already built homes. Said another way, when the copper, lumber, and other materials that comprise a home increase in price, the finished product being the house is then worth more.
With such a large portion of the college-age cohort never having experience in home buying, making themselves first-time buyers, they likely will be met with a stark reality of unaffordability and an environment that demands higher down payments as financial institutions limit their downside risk. Consequently, a shift in credit cycles could exacerbate the importance of having a more substantial downpayment if lending institutions were to restrict riskier loans (the usual event in economic downturns given the decline in financial stability). Even if the Prime Interest Rate were to double, they would only be slightly above the all-time median rate of 6.00% and slightly below the cumulative average of 6.81%. Put another way, due to inexperience and normalcy bias, younger generations discount the possibility of a credit crunch and/or economic downturn causing financial institutions to de-risk.
Energy Prices
On the whole, older generations’ consumption of transportation and associated commodities is heavier than younger cohorts. Not only do Gen-Z adults own fewer cars than older generations, but it can be assumed that they also consume a reciprocal amount of transportation commodities. Items (commodities) associated with transportation other than the obvious (oil as gasoline) would be items like tires, car accessories, vehicle parts, engine oil, coolant, and other fluids.
In fact, since 1983, the Federal Highway Administration has shown that the percentage of licensed drivers has been declining steadily. Furthermore, the rate of decline is more precipitous than the rate of older age groups. Between 1983 and 2018, driver’s license issuances to 18 to 24 year-olds declined 15.6%, in comparison with the 35–39 year-old category, which dropped by just 4.0% over the same period.
Due to the mass adoption of remote work and school, this trend can be projected to outpace prior years in decline. With fewer licenses issued, there would be fewer cars sold and repairs/maintenance performed, compared to older generations. Thus, younger people feel increases in the cost of gas and transportation commodities to a lesser degree when compared to their older peers.
Food Prices and the Gen-Z Diet
In certain categories, Gen Z is experiencing less inflation due to a declining reliance on meat as part of their main diet, a shift towards an environmentally-friendly mindset, and less favorable attitudes towards organic products than their older cohorts. Nonetheless, inflation is affecting both produce and meats, and these prices are not isolated incidents at the grocery store, but price increases are also being seen in restaurants.
While “meats, poultry, and fish” accounted for a 1.7% increase in the April 2021 CPI, individuals aged 18–24 are more likely to prefer easily prepared meals (58% vs 40%) as well as snacking (74% vs 66%) when compared to their older generations, suggesting a decreased weight of meat prices on their overall diet. So, while beef and chicken have surpassed their pre-pandemic price levels, Gen Z is, on the whole, shielded from price increases to a greater extent than their older peers. Contrarily, the price of “fruits and vegetables” only increased by 1.34% according to the April 2021 CPI, which suggests that young people saw a smaller increase in their food prices — emphasizing that smaller increases for cheaper food blur the real effect of inflation.
Diet choices also encompass how Gen Z views organic or minimally processed foods, whether that be positive or negative inclinations. In a 2020 study on Generational Perceptions Towards Organic Food Behavior, Gen Z was found to view organic product quality most negatively compared to any other generation. Moreover, in the same study, Gen Z contained the most disagreement on stating that organic products are tastier than their non-organic alternatives. Ironically, Gen Z’s focus on greener, more sustainable food does not mean that they value organic products as much as older populations.
Furthermore, according to Impossible Foods, Gen Z not only accounts for their largest customer base, but 62% are willing to spend more on products that do not harm the environment. Contrary to what one might believe, home food preparation is not a priority for Gen Z, even given their environmentally conscious spending. When asked, Gen Z stated that only 17% prepare homemade food daily and 37% prepared homemade food a few times a week — meaning that the 15% expecting to spend more on meal kit delivery services and 13% eating drive-thru foods is expected to grow in the coming years (which was accelerated with COVID-19). Without home food preparation, younger people will have to pay higher food prices due to service costs that are baked into the sale of fast-food and meal delivery services.
Real Earnings
Real earnings are the basis for consumption increases or decreases based on the relationship between wages and inflation. As of February 2022, real earnings are still lagging by 2.6% year-over-year. The news only gets worse using a constant measure of inflation (1980 CPI) with real earnings falling north of 10%.
While the government celebrates its intervention and stimulus during the height of the COVID-19 pandemic, the true ramifications of this spending are still to be seen. This is evidenced by using the PPI as a forward-looking indicator in relation to the CPI. With the delta between the CPI and PPI near 2%, consumers are likely to see even more price hikes in order to amend nominal and real revenue contractions seen in the prior two years. Whenever there is a difference between PPI and CPI producers are withholding price increases. In modernity, producers have lagged in their price hikes largely due to the “transitory” narrative of inflation expressed in prior months that was largely accepted by corporate America. Now that these same companies have to “catch up” to what they thought was temporary, the price hikes might have to be more drastic than they otherwise would have been given a more gradual onset of increases.
Interest Rates
With the cost of money being the main limiter on its supply, interest rates are seen as a way to curb inflation. All age cohorts expect interest rates to increase on average with the college-age individual averaging 1.25 and the older cohort averaging 1.343 (where the number 1 is the expectation that interest rates will increase and 3 denotes no rate change).
During the 1980s, interest rates had to rise to 20% to see a material decline in the rate of inflation. Today, with a higher measure of inflation than in the 1980s, could the U.S. bear interest rates higher than that of the famous stagflationary time period? Most would say, likely not, given the debt levels and the fact the U.S. is a net importer rather than an exporter.
In order for inflation to be tamed via interest rates, consumers have to be incentivized to stop their consumption, and rather save. This phenomenon requires positive real rates, something we are around 8% away from achieving.
Conclusion
Regardless of which measure of prices is used, purchasing power is being eroded faster than wage growth can keep up. This reduction in spending power will have to be met with a reduction in the standard of living across all generations. That may mean switching from sirloin steak to chicken breasts, or choosing to use the air conditioner less during the summer, but, nonetheless, the college-age individual may see a short-term shield from inflation only until they attempt to purchase real estate.
The rate of the consumer and producer price index is not slowing. Rather, real interest rates are accelerating their decline. The Federal Funds Rate seems to be too far off to have a chance at curbing inflation bar an overnight multi-percent rate rise, which is extremely unlikely. If the United States is to experience a time of recession or credit consolidation, all generations alike will have to deal with inflation concurrently with lay-offs and financial turmoil. Credit markets may be hit with a precipitous rise in risk and thus rates will follow, limiting the amount of debt-fueled consumption and discretionary spending young and old ages are used to.
In contrast to what inflation might look like at the supermarket, in both time periods studied (1978–1980, 2019–2022), the consumer expectation for inflation was largely aligned with CPI irrespective of its accuracy. This points to the inherent power that the government has to influence inflation predictions, whether they are aligned with reality or not. If inflation is to surprise to the upside (beyond consumer expectations), Gen Z and those living on a fixed income will be particularly vulnerable as they are reaching spending heavy ages in the next decade (marriage and retirement, respectively).