The Effect of High Interest Rates on Consumer Spending

The Effect of High Interest Rates on Consumer Spending

Note: We reveal investment insights through the quotes of top business leaders.

Key Takeaways

• High interest rates have increased borrowing costs and reduced consumer credit availability, leading to higher delinquency rates.
• Consumers are shifting spending towards non-discretionary items and reducing purchases of general merchandise due to economic uncertainty.
• The housing sector faces decreased affordability and low turnover, prompting homebuilders to adjust strategies to meet market demands.
• Demand for big-ticket items is declining, with companies offering financing incentives to spur purchases amidst higher interest rates.
• Consumer confidence is pressured by high interest rates, affecting spending behavior and overall economic outlook.

Impact on Consumer Credit and Borrowing Costs

High interest rates have led to increased funding costs and reduced borrowing capacity (DFS), higher deposit costs (WFC), and a rise in credit card borrowing (BAC). Efforts to maintain affordability include low down payment options (JPM), while delinquency rates have modestly increased (AXP).

“In addition to increased funding costs, deterioration in our credit ratings could reduce our borrowing capacity in the unsecured debt and asset securitization capital markets.” — (DFS, sec filing, 2024/Q1)

“with our average deposit cost up 10 basis points in the second quarter after increasing 16 basis points in the first quarter.If the Fed were to start cutting rates later this year, we expect that deposit pricing will begin to decline with the most immediate impact from new promotional rates in our consumer business and standard pricing for commercial deposits where pricing moved faster as rates increased, and we would expect betas to also be higher as rates decline.On Slide 5, we highlight loans and deposits.” — (WFC, earning call, 2024/Q2)

“Increasing our Closing Guarantee to $20,000 is a reflection of our confidence in getting customers into their new home without delay. Affordability and Access to Credit Chase offers low down payment options—as low as 3%—and flexible credit guidelines to create more homeownership opportunities for more people across the income spectrum.” — (JPM, press release, 2024/05/16)

“Consumer growth was driven by credit card borrowing, and while home lending balances were flattish, originations picked up a bit this quarter.” — (BAC, earning call, 2024/Q2)

“Turning now to the accounting of this credit performance on Slide 9. The quarter-over-quarter growth in our loan balances combined with a modest increase in our Card Member loans and receivables delinquency rate resulted in a $148 million reserve build.” — (AXP, earning call, 2024/Q1)

Changes in Consumer Spending Patterns

High interest rates and economic uncertainty are leading consumers to be more cautious, shifting spending towards non-discretionary items and reducing general merchandise purchases. This trend is evident across various sectors, from retail giants like Amazon and Walmart to quick-service restaurants like McDonald’s, reflecting a broader industry impact.

“In addition, changes in fuel, utility, and food costs, interest rates, and economic outlook may impact customer demand and our ability to forecast consumer spending patterns.” — (AMZN, sec filing, 2024/Q1)

“in a number of key markets, we continue to feel the impact of a more cautious consumer, particularly with our more occasional customer and a deteriorating economic outlook has weighed on customer traffic and impact felt broadly across the industry.” — (SBUX, earning call, 2024/Q2)

“Many consumer pocketbooks are still stretched, and we see the effect of that in our business mix, as they’re spending more of their paychecks on non-discretionary categories and less on general merchandise.” — (WMT, earning call, 2025/Q1)

“As consumer spending remains pressured and macro headwinds continue, we are laser-focused on maintaining our competitive advantages and growing QSR market share. With that, I’ll turn it over to Ian to talk more about our Q1 results.” — (MCD, earning call, 2024/Q1)

“And even as inflation moderates and we see sequential improvement in discretionary category trends, higher interest rates, uncertainty around the future of the economy, continued social and political divisiveness and the upcoming election cycle have consumers concerned about what lies ahead.” — (TGT, earning call, 2025/Q1)

Sector-Specific Impacts: Retail, Automotive, and Housing

High interest rates have significantly impacted the housing sector, leading to decreased affordability and historically low housing turnover. Companies like Lennar and D.R. Horton are adjusting strategies to meet affordability targets, while Home Depot and Lowe’s note the ongoing challenges in housing market strength and consumer adjustments to monetary tightening.

“This is most often the foundation of a very strong housing market. But the chronic supply shortage, the impact of interest rates on affordability as well as persistent and stubborn inflation has moderated housing market strength.” — (LEN, earning call, 2024/Q2)

“And we might be moving to a few more town home communities to try to meet affordability targets for a given sub-market. With regard to pricing increases or price decreases, that’s occurring very much week to week at a community level by our operators as they’re gauging their market demand, their inventory conditions, and their future lot supply.” — (DHI, earning call, 2024/Q3)

“So if we think about lock-in effect and the impact of housing turnover. Clearly, we’ve seen two years of significant decrease in housing turnover to the point where we’re at really sort of at historical lows.” — (HD, earning call, 2024/Q1)

“I think we’re watching consumers continue to digest and adjust to the monetary tightening, which is working its way through the system, and that continues to have an outsized impact on housing where we see affordability challenges and historically low turnover.” — (LOW, earning call, 2025/Q1)

“This is most often the foundation of a strong housing market, but the chronic supply shortage, the impact of interest rates on affordability and persistent and stubborn inflation have moderated housing market strength.” — (LEN, sec filing, 2024/Q2)

Effect on Big-Ticket Items and Financing

High interest rates are dampening demand for big-ticket items, with companies like Apple, Tesla, and Best Buy noting reduced consumer spending and a shift towards value deals. Homebuilders like PulteGroup and NVR are seeing financing challenges and increased cancellations, highlighting the broader impact on financing options and consumer behavior.

“And, you know, given you’re struggling to reduce your net — your — reach your net neutral cash position and your margins are sort of near highs, do you see ways to deploy capital more to spur replacement demand in your installed base either with greater device financing, more investment in marketing, more promotions.” — (AAPL, earning call, 2024/Q2)

“It’s on a 30 year fixed deal. It’s a heck of a deal. Even buyers that don’t use that because their delivery date’s kind of out beyond when the commitment can effectively be used, the incentives that we’re using are being almost entirely directed towards some sort of financing incentive.” — (PHM, conference, 2024/05/14)

“On the demand front, we’ve undertaken a variety of initiatives, including lowering the price of both the purchase and subscription options for FSD launching extremely attractive leasing specials for the Model 3 in the U.S. for $299 a month and offering attractive financing options in certain markets.” — (TSLA, earning call, 2024/Q1)

“Our backlog may be impacted by customer cancellations for various reasons that are beyond our control, such as failure to obtain mortgage financing, inability to sell an existing home, job loss, or a variety of other reasons.” — (NVR, sec filing, 2024/Q1)

“This, in combination with the pull-forward of tech purchases into the early years of the pandemic and lower levels of material innovation has led to continued lower demand for higher ticket consumer electronics and a focus on value and deals for current purchasers. We are not changing our original full-year” — (BBY, earning call, 2025/Q1)

Influence on Consumer Savings and Investment Decisions

High interest rates have led to a 26% decrease in consumer loans and interest receivable balances (PYPL). Financial firms like Charles Schwab manage interest rates to influence client cash balances and loans (SCHW). BlackRock aids in building savings and simplifying investments, even with automated retirement savings adjustments (BLK).

“The consumer loans and interest receivable balance as of March 31, 2024 and 2023 was $4.5 billion and $6.1 billion, respectively, net of participation interest sold, representing a decrease of 26%.” — (PYPL, sec filing, 2024/Q1)

“Because we establish the rates paid on certain brokerage client cash balances and bank deposits and the rates charged on certain margin and bank loans, and control the composition of our investment securities, we have some ability to manage our net interest spread, depending on competitive factors and market conditions.” — (SCHW, sec filing, 2024/Q1)

“is to help more and more people experience financial well-being. As a fiduciary to investors and a leading provider of financial technology, we help millions of people build savings that serve them throughout their lives by making investing easier and more affordable.” — (BLK, press release, 2024/04/18)

“In fact, over the course of Q2, client driven outflows from Bank Sweep, despite the seasonal tax payments, have been less than the cash flow generated from our investment portfolio, which in the absence of any other actions on our part would have led to to continued declines of supplemental borrowing.” — (SCHW, event transcript, 2024/07/16)

“It was a revolutionary, eliminating some of the guesswork for retirement savings by automatically adjusting their investment mix over the time frame.” — (BLK, earning call, 2024/Q1)

Psychological Impact on Consumer Confidence

High interest rates are contributing to consumer pressures and headwinds, impacting confidence and behavior. Companies like Nike and Starbucks are monitoring these macroeconomic conditions, while McDonald’s notes that affordability concerns are affecting consumer satisfaction. Overall, economic headwinds are challenging consumer confidence and spending.

“Severe weather conditions, natural disasters, acts of war, terrorism or other hostilities, social unrest or climate change (or expectations about them) can adversely affect consumer behavior and confidence levels, supply availability and costs and local operations in impacted markets, all of which can affect our results and prospects.” — (MCD, sec filing, 2024/Q1)

“We will continue to monitor macroeconomic conditions, including the potential impacts of inflation and higher interest rates on consumer behavior.” — (NKE, sec filing, 2024/Q3)

“Laxman Narasimhan: Thank you, Sharon. I think that if I look at the headwinds that, we see in the market in particularly with the consumer, and the pressures that they face.” — (SBUX, earning call, 2024/Q2)

“And I think if there’s any pressure on overall satisfaction or if there’s anything that’s closing it, it’s probably losing some of that relative superiority on affordability.” — (MCD, earning call, 2024/Q1)

“Just more broadly, your confidence, or I guess the prudence in maintaining what still is outsized growth with the headwinds seemingly large.” — (SBUX, earning call, 2024/Q2)

Effect on Different Income Groups

High interest rates are straining lower-income consumers, while higher-income groups show growth in delivery services. Retailers emphasize value across all income ranges, and initiatives like Amazon’s RxPass offer savings for fixed-income individuals.

“While our lower income consumers continue to deal with inflation, higher interest rates, and reduced government benefits, we are encouraged that the worst of the SNAP headwinds appear to be behind us.” — (DLTR, earning call, 2024/Q1)

“But again, it was strong on both sides of that point, that $100,000. Ernie Herrman: Lorraine, I would just also jump in on one of the things that we believe is healthy for us, again, as we talked about in the beginning of the way we trade to good, better, best on the age demos, where we have been appealing to more younger customers, it — what’s been great is we also track the age group and the income groups like John is saying, and we are pretty balanced.” — (TJX, earning call, 2025/Q1)

“And in the delivery business where we are stronger with higher income consumer, that’s where we’ve seen a lot of growth.” — (WMT, earning call, 2025/Q1)

“Looking ahead, we expect value to continue to be the most important consideration for customers in multiple income ranges.” — (DG, earning call, 2025/Q1)

“This could save people (many on a fixed income) about $70-$120 per year if they take just one medication, and if all Medicare beneficiaries transitioned their eligible medications to RxPass, Medicare spending could be reduced by nearly $2 billion.” — (AMZN, Twitter, 2024/06/18)

Overall Economic Outlook

High interest rates are leading to a cautious economic environment, with companies like Berkshire Hathaway building cash reserves. Concerns about inflation and its potential global impact are significant, highlighting the dollar’s critical role as a reserve currency amidst economic uncertainties.

“That’s what I actually thought, one of the strangest things was. He said that he did this because he didn’t mind building up the cash hoard at this point because of the environment that’s taking place, I guess the economic environment, the stock outlook.” — (BRK.B, event transcript, 2024/05/04)

“And then it won’t be the quantity. It’ll be whether in any way inflation would get let loose in a way that that really threatened the whole world economic situation and there really isn’t any alternative to the dollar as a reserve currency.And you get a lot of people who give you a lot of speeches on that, but that really is the answer.” — (BRK.B, event transcript, 2024/05/04)

See also

Federal Reserve Decisions: Impact on Retail Giants

See what companies say about this topic.

Industrial Services Sector: Strategies for Overcoming Market Challenges

See what companies say about this topic.

AI Integration: Transforming Consumer Devices

See what companies say about this topic.

Investment Strategies Amid Consumer Weakness

See what companies say about this topic.

How Natural Disasters Are Shaping the Insurance Industry

See what companies say about this topic.

Disney’s Strategic Moves: Can New Bundles and Theme Park Innovations Revitalize Growth?

See what companies say about this topic.

PACCAR’s Strategic Response to Inflationary Pressures and Capital Spending Challenges

See what companies say about this topic.

Disney’s Leadership Changes in Animation: Implications for Future Growth

See what companies say about this topic.

Table of contents

• Impact on Consumer Credit and Borrowing Costs
• Changes in Consumer Spending Patterns
• Sector-Specific Impacts: Retail, Automotive, and Housing
• Effect on Big-Ticket Items and Financing
• Influence on Consumer Savings and Investment Decisions
• Psychological Impact on Consumer Confidence
• Effect on Different Income Groups
• Overall Economic Outlook

Household Consumption: The Engine of Aggregate Demand (Determinants and Impacts)

What’s is: Household consumption refers to the final household expenditure on goods and services. Items can be classified as durable goods, nondurable goods, and services.

Factors Affecting Household Consumption

Income is the main determining factor for household consumption. Without income, households do not have money to buy goods and services.

Apart from income, other factors affecting household consumption are:

• Wealth
• Future income expectation
• Interest rate
• Inflation
• Income distribution
• Demographic factors
• Tastes and preferences

Disposable income

In macroeconomics, among several variables, disposable income is the primary determinant of consumption. Economists state household consumption as a function of disposable income.

We calculate disposable income by deducting the tax from household income. Income here includes those received from transfer payments.

Thus, disposable income increases when:

• Pre-tax income increases
• Income tax is down

From disposable income, households have two main choices, save or consume. An additional 1 dollar of income allocated to consumption refers to the marginal propensity to consume (MPC). Meanwhile, the extra saved is referred to as the marginal propensity to save (MPS).

MPC plus MPS must be equal to 1. The concept of MPC is useful for explaining the multiplier effect of consumption on the economy. A high MCP increases the impact of consumption on the economy.

Wealth

Household wealth consists of real assets and financial assets. When the prices of assets such as stocks and bonds rise, household wealth increases.

Higher wealth encourages households to spend more. When their assets increase, they feel they have hit their wealth-gathering target. Therefore, they will spend any additional income on the consumption of goods and services.

We call the relationship between asset prices and expenditure the “wealth effect.”

You need to remember. In this case, we assume that the liabilities (such as a mortgage loan) do not change.

Future income expectation

Household optimism affects spending behavior. If households are optimistic that their future income will increase, current spending will increase. This condition generally occurs when economic growth is expanding.

Economic expansion brings more prosperous conditions. The unemployment rate is low, and the income outlook is improving.

Conversely, during a recession, the downward pressure on income and consumption increases. Households are becoming more pessimistic about their jobs and income. Shrinking economic activity indicates that businesses are likely to cut their labor, pushing the unemployment rate higher.

Interest rate

Interest rates affect household consumption and saving behavior. An increase in interest rates stimulates households to save more to obtain higher interest income. As households save more, the allocation for consumption is reduced.

Interest rates also increase borrowing costs. Households often rely on bank loans to purchase items such as cars and houses. Consequently, when interest rates rise, they tend to delay such purchases.

Conversely, lower interest rates reduce borrowing costs. Households will usually apply for new loans to facilitate the purchase of durable goods.

Also, low interest rates mean low-interest income. As a result, they are likely to save less.

Inflation rate

Inflation and its expectations influence consumption decisions, primarily through their effect on real income and the real interest rate.

For example, when households expect higher inflation in the next month, they are more likely to buy durable goods now. That’s because current income has a greater purchasing power than in the future.

Conversely, if households expect deflation (falling prices) next month, they will postpone their current purchases. They will buy in the next month, hoping to get lower prices.

Income distribution

Income distribution refers to how total income is divided among the population. It’s a crucial factor influencing household consumption because spending habits vary significantly between income groups. Here’s a breakdown:

• High-income households typically have a lower Marginal Propensity to Save (MPS). This means they spend a larger portion of their disposable income on consumption. They may have already met their basic needs and have more discretionary income for luxuries and experiences.
• Low-income households often have a higher Marginal Propensity to Save (MPS). They dedicate a larger portion of their income to essential needs like food and housing, leaving less for discretionary spending.

Demographic factors

Demographic factors like age, education, and family size significantly influence household consumption patterns. Consider these points:

• Age: Younger adults may spend more on entertainment, dining out, and establishing their households. Consumption patterns shift as people age, with a focus on necessities, healthcare, and potentially saving for retirement.
• Education: Higher education levels often correlate with higher incomes, potentially leading to increased spending on a wider range of goods and services.
• Family size: Larger families typically have higher consumption needs due to the increased demand for food, clothing, and housing.

Tastes and preferences

While challenging to quantify, tastes and preferences undeniably influence consumption patterns. These factors are driven by:

• Individual values: What people value most, such as experiences, luxury items, or practicality, will guide their spending decisions.
• Social influences: Trends, peer pressure, and societal expectations can shape how people choose to spend their money.
• Marketing and advertising: Companies use marketing strategies to influence consumer preferences and create brand loyalty.

Why is household consumption important?

Consumer behavior is the engine that powers economic activity. Consumption theory acts as our roadmap, helping us understand how individual spending decisions translate into real-world outcomes.

Key concepts like consumer surplus, decreasing marginal utility, and the law of demand illuminate how these choices influence the production of goods and services. Consumer surplus refers to the difference between the price a consumer is willing to pay for a good and the price they actually pay. Decreasing marginal utility explains the diminishing satisfaction gained from consuming additional units of a good.

Finally, the law of demand highlights the inverse relationship between price and quantity demanded – as prices rise, consumers tend to purchase less. By understanding these principles, we gain valuable insights into how individual choices regarding spending ultimately shape the production of goods and services within an economy.

Keynesian economics further underscores the critical role of consumption in driving economic health, particularly concerning income and employment. This theory posits that insufficient aggregate demand, the total spending on goods and services in an economy, leads to decreased production.

When production falls, businesses are compelled to reduce their workforce, resulting in unemployment. This rise in unemployment translates to a decline in overall disposable income, which in turn dampens consumption even further. This vicious cycle, if left unchecked, can spiral into a recession.

Keynesian economic theory emphasizes the importance of government intervention to stimulate aggregate demand through measures like fiscal policy and monetary policy, aiming to prevent such downturns.

The effect of household consumption on the business cycle

Household consumption expenditure contributes around 68% of the US Gross Domestic Product (GDP) in 2021. Consumption falls into three categories:

• Durable goods are tangible items with a useful life of more than three years
• Nondurable goods, such as food and beverages, are entirely consumed once.
• Services, which are the act of helping or doing work for another party.

Consumption spending can help understand fluctuations in the business cycle. During the economic recession phase, spending on durable goods decreases. They are expensive, and to buy them, households often borrow from banks. Therefore, during this period, they will postpone purchases until economic conditions improve.

As the economic recovery progresses, spending on durable goods increases. Because the price is relatively high, consumers will usually ponder carefully before buying.

When they see the economy will be better off in the future, they will buy it right away. Moreover, interest rates will usually remain low in this situation because the central bank is most likely to still keep interest rates low. The central bank will raise interest rates if the economy enters an expansion phase.

Hence, buying durable goods early in the economic recovery makes sense. Ultimately, the consumption of these durable goods will increase aggregate demand in the economy. That will stimulate businesses to increase output, bringing the economy into an expansionary phase.

LEARN MORE

• How Household Wealth Affects Aggregate Demand and the Economy
• Decoding the Aggregate Demand Curve: Understanding Its Slope and Determinants
• Consumer Confidence: Its Effect on Aggregate Demand and the Economy
• Understanding Consumption Expenditure: Types and Examples
• How Fiscal Policy Affects Aggregate Demand and the Economy
• How Monetary Policy Works Affects Aggregate Demand and the Economy
• How Exchange Rates Affect Aggregate Demand and the Economy
• How Consumption Expenditure Affects the Economy
• How Disposable Income and Spending Habits Affect Consumption Spending

About the Author

I’m Ahmad. As an introvert with a passion for storytelling, I leverage my analytical background in equity research and credit risk to provide you with clear, insightful information for your business and investment journeys. My expertise also extends to Wellsifyu.com, where I empower you with smart shopping insights. Learn more about me

TRENDING

• Sociocultural Environment: Key Factors Impacting Businesses
• Values, Attitudes and Lifestyles (VALS): Categories and Why They Matter
• Business Size: How Business Scale Shapes Success (Importances, Measurement, Classification)
• Conglomerate Integration: Unrelated Businesses, Diversified Supply Chains (Examples, Pros, Cons)
• Marketing philosophy: Meaning, Importance, and Types
• Large Businesses: Roles, Classifications, Characteristics, Advantages, Disadvantages
• Assets-to-Equity Ratio: Calculation and Interpretation

https://www.onwish.ai/insights/the-effect-of-high-interest-rates-on-consumer-spendinghttps://penpoin.com/household-consumption/