Wharton finance professor Itay Goldstein evaluates the economy and explains why current indicators make it difficult to predict the future. This episode is part of a series on “Holiday Retail.”


How Did COVID Change Consumer Spending?

Dan Loney: Consumers have been spending big over the last three years. The financial assistance from the government during the time of COVID, combined with other factors like no student loan payments, have allowed people to buy things, spend money fixing up their home, or take a vacation. But now we have higher inflation for the first time in several decades, and that could lead to a change in spending patterns. What will this mean for the economy?

Itay Goldstein: When you go back to thinking about COVID, it was a period of time where people could not spend. They could not do things that they like to do. They could not take vacations. They could not eat in restaurants. It’s been a good two years or more that people felt constrained on all of these things. I think once we passed COVID and people see that they can go out again, they can go back to living their lives, there is a little bit of a change in the psychology of spending. One thing to think about is, there are all these missed experiences.

But I think even beyond that, something has changed. Because people realized, you know, “I should probably spend and consume and have a good time today, because who knows what’s going to happen down the road.” I think those two things have changed during COVID in the aftermath of COVID, and led people to think a little differently when they decide how much they want to spend.

I would say, maybe a little speculatively, something else is happening now big time. And this is climate change. There is climate change itself, but there is also the awareness of it. If you go back to think about all the news we saw over the summer about unprecedented weather, and things are changing quickly, and more quickly than we thought — I think people start having this in mind. Who knows what’s going to happen? Let’s just do it as quickly as we can because things around us are changing. And maybe things that we are doing today, we will not be able to do a couple years from now. Or maybe things will change, and we will just not have the same opportunities.

Loney: I guess it’s probably not a surprise to see people spending when we’ve got inflation because, as you said, we were blocked out of a lot of this for such a period of time.

Goldstein: Yes. In general, when you have interest rates going up and inflation at high levels, usually these are the kinds of thing that will push people to spend less. But what we have is the dynamics of going out of COVID, and the fact that people have all these missed experiences and things that they want to do. This was certainly very strong in the first year after COVID, but I think it still has an effect.

And the psychology that has changed. The fact that people now say, “Who knows when I will be able to do it again? I should probably just do it now.” I think this is kind of a counter-effect to the inflation and the interest rate, and pushing people to spend more, despite these traditional economic forces.

How Can Retailers Deal With Uncertainty?

Loney: How much of it is a tale of two stories here, with the people that have and the people that have not?

Goldstein: We always have a story of inequality. Some people have money to spend, and they’re spending more. Other people don’t have, and they are spending less. And in some sense over time, we do unfortunately see these gaps going. Certainly, the fact that interest rates are high is affecting some people much more adversely than others, and I expect that we are going to continue seeing that going forward.

We are sitting here and talking about the fact that people are generally spending a lot. I don’t think this is unbounded. I do think there is some boundary to it. And at some point, we will see that it is starting to reverse. It is important to know that we already see some of the signs of reversal, or slowing down, showing up in recent data. It’s not that, when you look at the data, this is unambiguously strong and going in just one direction. It is a bit of a mix. I would say in general, what you see is a level of spending that is above experts’ expectations given the economic conditions. But there are some people who spend more, some people who don’t. I also think that when you look at the aggregate, it’s a bit of a mix. It’s not like it is unambiguous increase.

Loney: If there is a slowing of the economy, how much do we potentially slow down?

Goldstein: I think this is still a “wait and see.” This is the big question that is on everyone’s mind. If you think a little bit about the economic developments of recent years, we’ve seen a period of high inflation, then the Fed is coming in and starting to increase rates really fast and really substantially, much more than was originally planned. And the expectation was that this is going to slow down the economy, potentially bring recession, but at least it will help us fight inflation.

We haven’t seen the recession coming in yet. That’s the good news. But the bad news in that is that we also did not see inflation fully under control. It is true that inflation did not continue to go up. If you’re thinking about the rate of increase in prices, it has slowed down. From a rate of 9% percent or so, we’re now down to 4%. This is OK, but 4% is still pretty high, and higher than policymakers are comfortable with. So, we are still not out of the woods. They are still continuing to try to slow down inflation and bring it back towards the 2%. As long as they are continuing to do that, there is still the chance that there will be a significant slowdown in the economy, and we might even see a recession.

Loney: There’s the consumer side of this, but there’s also the business side. How much of a challenge is it for companies, especially retailers at this time of year, to adjust to this dynamic?

Goldstein: All firms are now thinking about these different scenarios. What this is going to imply to their revenues and ultimately to the bottom line? Overall, it’s ambiguous. Some will be more optimistic, some are less optimistic. And it’s really hard to tell where it’s going to go.

When I look at what happened in the last few months, I think the signs are overall fairly encouraging. We do see spending still fairly strong, and I think there is a good case to believe that it’s going to continue being strong going into the holidays. So, the end of the year is going to be good for many firms in that respect. But there are so many forces going on. Interest rates are still high, and the reserves that allowed people to spend more are dwindling. There will be some inflection point, and we might see it starting to go the other way.

Loney: Is there an element of that spend that you think is still out there?

Goldstein: I think so, yes. You mentioned those who have and those who have not, and clearly that’s true. That’s there. From the point of view of many households, they don’t have the money to spend. Or whatever they had, whatever they accumulated during COVID, is gone. But we still have a significant portion of the population that has those significant reserves and can spend. I still think the psychology of COVID and the fact that they have a deficit of spending in their mind — they wanted to do all these things, and they didn’t do them — combined with the fact that they still have money to do it, still pushes them to spend. And I think this is what we see in the data.

What Should Leaders and Consumers Expect in 2024?

Loney: What’s been the impact on the mindset of the Federal Reserve and leaders in terms of making these rate increases? Is there another rate increase needed? Or can we let it sit for a while and see how the economy reacts?

Goldstein: When you listen to the leaders of the Fed — the people at the board, the presidents of the regional Fed — they are basically watching it as we go and continuing to update almost on a daily basis, Whenever I listen to them and talk to people who work there, there is a sense that what we are seeing is not exactly what we expected and doesn’t really go by the book according to recent experiences. So it’s a bit of a novel dynamic that we see here. But life continues to have novel elements, right? You never see exactly what you have seen before. And I think this is what we see here.

They are just watching the data continuously and trying to decide what to do. As you know, there was a period of time where they paused the rate increase, because they thought that they’ve done enough of it, and now they want to see how it affects the economy. They don’t want to overshoot, because the risk of overshooting is that you’re going to push the economy into a severe recession. That has been the mindset recently. But there are certainly some other voices. I think it really depends on how the data evolves.

Loney: How should companies be thinking about their quarterly expectations with all of these dynamics at play?

Goldstein: I think all companies are in exactly the same position. They are updating as we speak, and they are continuously watching the data and deciding what to do. In some sense, this is not unusual because this is what they always do. It’s not like you can think about a period of time where there is no uncertainty and we know exactly where we are going. There are always different factors pushing in different directions, and you always need to update.

But I think it will be fair to say that this is a period with increased uncertainty because of all these things that we discussed. They have to continuously watch what the Fed is doing, what spending is. When you’re thinking about spending, it’s at the macro level, but also at the industry level and the level of their own firm. They are making predictions based on that.

Loney: What is the message to the public about what we’re seeing play out right now, with what we’ve seen with the Federal Reserve, and how companies are reacting as we head towards the end of the year and think about 2024? I think a lot of people are hoping it will be a better year.

Goldstein: Yes, I think that’s a fair statement. But we don’t really know. As we discussed, there are still those headwinds coming our way — interest rates are still high, inflation is still not completely under control. People hope that there is a soft landing, but we haven’t seen it yet. We might fall into alternative scenarios. One scenario is the scenario of no lending at all, where inflation is still up there and not fully under control. Another scenario is a scenario of lending but is not so soft, so we are going into a recession. Going into 2024, I think there are reasons to be optimistic and hope for a soft landing, but it’s certainly not guaranteed.