The Federal Reserve is currently in a tough battle to dampen economic activity and bring inflation down to its target of 2%. However, the strength of the stock market in 2024 is making this fight even more challenging. The recent all-time high in the market is leading to consumer behavior that complicates the Fed’s mission.
The wealth effect, a behavioral theory that suggests people tend to spend more when their wealth increases, is playing out in the U.S. economy. A recent survey by Gallup found that 62% of U.S. adults have money invested in the stock market, indicating that a large portion of the population is benefiting from the market’s performance. Even low-income households and the middle class own equities, suggesting that many Americans could be enjoying a higher net worth due to the market’s performance.
This increased wealth is leading to higher consumer spending, which further stimulates the economy and inflation. The Fed is now facing a dilemma as it tries to balance controlling inflation with not raising interest rates too high and risking slowing down the economy. Some analysts believe that the Fed may need to raise interest rates again to control inflation, especially with the stock market acting as an added level of stimulus.
However, others argue that the stock market can continue to rise even with inflation above 2%, as long as inflation doesn’t over-accelerate. The future remains uncertain, but if the Fed can’t meet its inflation target while the stock market continues to grow, we may see some challenging times ahead. The wealth effect from the market’s strength is leading to increased spending, making it even harder for the Fed to control inflation.
