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The writer is the Rene M Kern Professor at the Wharton School, chief economic advisor at Allianz and chairman of Gramercy Fund Management
As the recent US election has suggested, no word better captures the American public’s concerns than “affordability.” As in other countries, concerns are amplified by daily media coverage of a simple and convenient opponent: prices.
It’s a dynamic that market participants will need to pay attention to as affordability challenges increase, especially as workers worry about workplace changes related to artificial intelligence. Political pressure will require policy responses that will also impact markets.
The focus on prices is understandable. The 2021-2022 inflation wave was a major shock that turned the cost of basic commodities, such as groceries and utilities, into a source of pain. For politicians, fighting the cost of living became a clear, concise and compelling rallying cry, made more attractive by the opportunity for a lot of finger-pointing, whether about government spending, central bank policy or ‘corporate greed’. Voters’ anger was amplified by the discrepancy between what they heard at the time (inflation is falling) and what they expected to see (lower prices instead of a lower price increase).
Yet this focus on prices as a measure of affordability is far from sufficient. It ignores a crucial part: what people earn. And it is incomes that are now under greater pressure, exposing the vulnerable financial base of too many households.
In previous decades, the ‘affordability crisis’ was a slow, structural problem, masked by low headline inflation. The problem was not that the price of groceries rose shockingly, but that the costs of the core components of middle-class life – housing, education and health care – rose consistently to worrying levels.
The 2021-2022 inflation wave turned a chronic condition into a potentially more acute one. Its immediate impact on purchasing power was offset firstly by government income transfers and secondly by rapidly rising wages, especially for lower-income households. That income increase is fading, as evidenced by data showing not only lower income growth but also more vulnerable lower-income households as significant laggards.
No wonder the Trump administration has focused on ensuring lower costs for energy, pharmaceuticals and mortgages in particular. Yet fears about incomes are rising due to the uncertainties associated with the impact of AI in the workplace and the increase in layoffs, as reported last week by outplacement firm Challenger, Gray & Christmas.
And affordability isn’t just about real numbers; it is also about perceived stability. It’s especially troubling for households when they feel like they’re running on a treadmill and working harder just to risk falling behind. This “vibecession,” in which the lived experience of economic uncertainty overrides positive macroeconomic headlines, has been particularly problematic for the Biden administration.
Households also tend to judge themselves against others, with today’s unequal economy fueling a greater sense of “relative deprivation”. This undermines the implicit social contract built on the promise of upward mobility: If you work hard, your children will be better off than you, and you’ll have a shot at the American dream. And when a society moves from a state of collective ambition to a state of uncertainty, the political implications can be profound. It can fuel a deep sense of cynicism and mistrust of the political establishment and big business.
Viewed through this lens, it becomes crystal clear that the current affordability crisis will not be solved simply by returning inflation from the current 3 percent to the Federal Reserve’s target of 2 percent. What is needed is an approach that also addresses the income side of living standards in a sustainable, inclusive and, above all, future-oriented manner.
This is partly about a more comprehensive policy focus on traditional growth engines, such as infrastructure and deregulation. But policymakers must also ensure that the spread of AI’s exciting job-enhancing promise is not overshadowed by its labor-replacing aspects. It is a joint responsibility of governments, companies and households that has not yet attracted the necessary attention.
Until this happens, affordability will become even more important. If left unaddressed, we risk economic instability, social fracture and political polarization, while limiting AI’s potential to increase productivity and growth.
