Wealthy Americans cause inflation by over-spending and investing government benefits---pandemic proves.

Perhaps the most overlooked engine fueling inflation is the “wealth effect,” the extra spending from Americans feeling flush as their stock portfolios and home prices jumped by trillions during a tag-team, Olympic sprint for both. By far the biggest share of the extra outlays on the likes of new cars, home improvements, and laptops comes from America’s top income tiers. Besides opening their wallets as their net worth swelled, those high-earners—who own the most expensive houses—tapped the fast-rising value of their manses as ATM-style fonts for cash. The sudden spike in their nest eggs and their cash-out refis keep the cohort spending at rates far faster than before the pandemic struck. And because that elite group accounts for such a huge share of overall consumption, it’s also a leading, and widely ignored, force in driving inflation that reached 7.5% in the January CPI reading, the highest level in four decades.

Put simply, the well-to-do, hugely compensated Americans contributing greatly to soaring prices is the class least damaged by the rampant inflation. So far, higher prices don’t seem to bother them and have done nothing to curb their record shopping spree. If deep-pocketed families feel the inflation pinch at some point, they harbor plenty of wiggle room to trim back by shortening vacations, ordering fewer features on a new Chevy Suburban, or dining out once instead of twice a week.

Instead, the big inflation partly spawned by the highly paid takes its stiffest toll on low-income Americans. Those hard-pressed folks typically don’t buy stocks and are most frequently renters, not homeowners. They’re the people driving the old cars leading the budget-busters list, and spend much more of their incomes on such essentials as gasoline and groceries. Since they’ve got less if any leeway to reduce spending on fun stuff such as restaurant meals and vacations, they suffer the full impact of gale-force inflation. “Forget supply-chain problems,” says Ed Pinto, former chief credit officer at Fannie Mae, and director of the American Enterprise Institute’s Housing Center. “The wealth effect hit in a big way around mid-2021, helping drive inflation, and what’s causing it is the Fed’s easy money policies.” As Wells Fargo analysts put it in a recent report on the phenomenon, “The spending [causing inflation] is steered by a select few”—meaning higher-income households.

Inflation is effectively a “tax” that falls most heavily on lower-income households. They devote much more of their incomes to buying goods and services than high-earners, who accumulate the savings to buy those houses and stocks that have risen so much in value. As Elon Musk put it in a recent tweet, “Inflation is the most regressive tax of all.”

The wealth effect’s sources

The wealth effect is a well-established financial lever that past Fed chairmen including Alan Greenspan and Ben Bernanke have praised, and succeeded in creating, via ultralow interest rate policies and, more recently, quantitative easing. Those policies raise asset prices, and hence spur consumer spending that lifts economic growth. Greenspan boosted the wealth effect to navigate the early 2000s dotcom collapse, and Bernanke deployed it to reboot expansion following the Great Financial Crisis. Without talking much about the wealth effect, current Chair Jay Powell invoked precisely the tools that generate it by pursuing both a zero interest rate and quantitative easing policy during the pandemic. Only this time, the wealth effect dwarfs its size in any previous period, to the point where it’s now the supercharged motor helping drive the inflation rampage.

As Pinto points out, economists generally posit that every $100 gain in wealth translates into a $3 or 3% increase in spending. As Americans’ wealth grows, they become more confident that their financial futures are assured. They’re willing to buy more now, knowing they can always sell those assets in the future for much more than they paid.

For Pinto, the wealth effect has four components.

The first and biggest is the explosion in equity prices. In the year after recovering from the pandemic-induced swoon, the U.S. stocks have added $12 trillion in value. The wealth effect from those gains added $360 billion a year in extra consumption (3.0% of $12 trillion).

The second factor is $6 trillion in home price appreciation, or HPA. “In almost every boom, it’s the lower end of the housing market that appreciates much faster than the high end,” says Pinto. “But for almost a year, the value of expensive homes has grown at the same rate as low-priced houses.” Here the contribution is another $180 billion. His AEI numbers show that high-end values have risen 27% since the start of 2020, and that the gains in the top quintile of homes account for an outsize share of the $6 trillion increase, given that the well-to-do have the highest homeowner rates, the priciest homes, and most equity.

Third, the Fed-engineered sharp decline in rates enabled millions of homeowners to refinance at lower monthly costs. That break handed them $280 billion a year in extra cash.

Fourth, as home equity grew, Americans rushed to tap that equity. Cash-out refis put an additional $90 billion in their pockets. The total wealth effect from the asset gains and using your house as a cash machine is over $900 billion. Its full impact hit the economy late last year and will continue well into 2022.

High-income consumers are a major force in driving the boom in spending—and inflation