Investing.com — K-shaped dynamics, characterised by divergence in spending growth between higher- and lower-income households, emerged in the late 2024-early 2025 period. BofA observes that during this time, the top 10% of households were responsible for roughly 23% of consumption, while the bottom 10% were responsible for just 4%.
In a K-shaped economy, outcomes for different groups are sharply different over the same time period, with one arm of the K sloping up to represent those enjoying good outcomes and the other arm sloping down to represent those facing economic stagnation or decline.
A key implication of a K-shaped economy is that demand comes to depend on the willingness of those with high spending power to spend. “K-shaped spending makes aggregate demand disproportionately dependent on higher income balance sheets, wealth effects and spending behaviour,” says BofA.
This is why, say firm analysts, demand was resilient in an environment where lower-income households were grappling with rising rents, higher debt, elevated energy costs and softer outcomes in the labour market.
Job growth and consumer sentiment weight all consumers equally, so broader economic activity can continue apace even when these factors deteriorate, provided that K-shaped spending continues.
BofA says this is exactly what happened when immigration restrictions created a labour slowdown, but more service-oriented higher-income spending continued, and labour demand ultimately stabilised since the vast majority of jobs are in services.
The same lesson can also be gleaned from the pandemic recovery.
“Pandemic-era fiscal support and excess savings helped fuel a stronger US recovery than the “sluggish” one in Europe. This extended beyond household balance sheets: foreign demand for US assets helped finance large deficits, while strong corporate profitability supported investment and jobs,” BofA analysts said in their note.
The danger of the K-shaped dynamic is that headline consumption growth masks underlying stress elsewhere in the economy.
“Traditional signals of consumer weakening, such as rising delinquencies or softer hiring among lower-wage workers may coexist with steady overall spending, complicating real time assessments of consumer health from the perspective of the broader economy,” added BofA
The firm says today’s K-shaped consumer is a product of higher-income households benefiting from large macro shocks interacting with unequal financial buffers and asset gains.
Higher credit costs and a widening gap between rising rents and largely fixed mortgage payments downstream from Fed tightening is responsible for reinforcing the K, says BofA. But Fed policy might not be able to fix the problem.
The two arms of the K each call for different policy prescriptions: higher-income households see reflation with a demand boom, while lower-income households face mild stagflation.
BofA thinks the Fed’s recent reaction is in line with their recommended strategy of a gradualist approach.
Ultimately, the effectiveness of Fed policy in addressing rising inequality is constrained by fiscal space, inflation risk and market tolerance. While targeted support for lower-income households might offset shocks like higher energy prices and prop up demand amidst uneven economic pressures, with the deficit at 6%, competing fiscal priorities and demand-driven inflation risk, the room for fiscal policy is limited.
Source:
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