How Food and Energy Crises Contribute to Economic Downturn

Bills of $20 denominations are counted in North Andover, Mass., in a file photo dated June 15, 2018. Elise Amendola/AP Photo

News Analysis

If more households are paying more for food and energy, will they modify their consumption patterns?

With consumer demand gradually weakening and business activity slowing down, the consequences of surging food and energy inflation might be weighing on the broader economy.

But what are the data showing, and how are higher food and energy prices fueling the recession?

Paying More for Food

In July, food inflation hit 10.9 percent, the highest level since May 1979. Across the board, every food and beverage item listed on the Bureau of Labor Statistics’ consumer price index has surged on a year-over-year basis, from bread to meat to coffee.

Food prices might not ease for quite a while, as the Department of Labor reported that prices paid to U.S. producers for finished consumer goods increased nearly 16 percent in the 12-month period ended in July. This represented the biggest increase since 1974.

Although commodity markets have eased in recent months, many agricultural products are rising again, including soybeans, wheat, corn, lean hogs, and coffee.

The United States, for example, is poised to harvest its smallest corn crop in three years.

This is bad news for households already struggling to cover the cost of their grocery store bills.

According to a new study by LendingTree, U.S. households are spending 28 percent more on food than they were a year ago, as they spent an average of $407 per week on food in July, up from $318 in May 2021. In addition, the percentage of Americans reporting food insufficiency—not enough to eat—and relying on credit cards to pay for groceries has swelled.

Keeping the Lights on Is More Expensive

Despite crude oil and gasoline prices coming down, the energy price index remains up 32.9 percent on an annualized basis. Fuel oil has advanced 75.6 percent, gasoline has climbed 44 percent, and electricity costs have jumped 15.2 percent.

The meteoric boost in energy prices forced drivers to change their habits.

Industry surveys show that motorists are driving less, combining errands, and doing fewer leisure activities because of the exorbitant cost of gasoline. Moreover, Energy Information Administration data show that gasoline demand stood at 8.434 million barrels in the week ending Aug. 19.

Electricity costs have become so outrageous that 20 million households can’t afford to pay their monthly utility bills. Increasing power costs have led to a collective electric bill of about $16 billion in June, double the $8 billion from December 2019.

Businesses are also enduring the agony of higher utility costs.

In June, Century Aluminum Co., the second-largest aluminum mill in the United States, which accounted for one-fifth of domestic supply, had to idle its Kentucky plant because it couldn’t afford the electricity bills.

Broader Effects on the Economy

Falling consumer demand is already weighing on business activities, according to various metrics.

The S&P Global Manufacturing Purchasing Managers Index (PMI) eased to 51.3 in August. The Services PMI fell to 43.7, while the Composite PMI dropped to 44.6. Anything below 50 indicates a contraction.

Economists at S&P Global noted that higher input prices diminished consumer demand, with many firms reporting that clients were concentrating on inventories and essential spending more closely.

Sian Jones, the senior economist at S&P Global Market Intelligence, explained that the August PMI numbers painted a concerning picture of the state of the U.S. private sector. Demand conditions are weakening, Jones noted, as rising interest rates and elevated inflation weigh on customer spending.

The situation might deteriorate further as the slump in total output is comparable to what happened during the Great Recession.

The U.S. economy is two-thirds driven by consumer spending. If Americans aren’t purchasing goods and services because their main focus is on sustenance, be it filling up a tank of gas or putting bread on the table, business activity shrinks, and the gross domestic product takes a hit.

Indeed, market analysts have been closely monitoring consumer demand data in recent months to find hints of a slowdown.

In July, retail sales were flat at zero percent, while personal spending edged up at a lower-than-expected pace of 0.1 percent. The personal savings rate also dipped to just 5 percent, the lowest since 2008.

According to a new report by First Insight, a platform that tracks consumer experience, people are changing how they spend their money. The report titled “The State of Consumer Spending: Inflation Fueling Recession Fears” states that rising food prices are the biggest concern for 68 percent of consumers. This has them cutting spending in other areas, including dining out, streaming services, electronic games, and gym memberships.

Even priorities and behaviors in consumers’ food budgets are changing, said Greg Petro, CEO of First Insight.

“As inflation remains at the highest levels seen in the U.S. since 1981, consumers continue to find different ways to afford things,” Petro said in a statement. “Putting food on the table remains consumers’ top priority. We are seeing reallocation of food budgets, with many consumers cutting back on fresh produce and spending less on name brand products.”

On the energy front, the World Bank warned in a June blog post that “energy price shocks” can trigger “immediate repercussions” on economic activity and then result in wider consequences, from fiscal and monetary policy to investment uncertainty.

“The restart is stalling in the U.S. as it bumps into production and labor supply constraints, and we believe U.S. activity is now set to contract,” Tara Sharma, an investment strategist at BlackRock Investment Institute, wrote in a note.

Will the US Become Europe?

While the United States might be in the beginning stages of a sharp contraction in business activity amid inflationary pressures in food and energy, Europe has become entrenched in this cycle for months.

Eurozone growth has slowed down considerably, with factories across the region reporting a significant decline in demand as rising energy bills and the broader cost-of-living crisis impacted customers’ finances. The Eurozone S&P Global Manufacturing, Services, and Composite PMIs slipped to 49.7, 50.2, and 49.2, respectively, in August.

A growing chorus of economists believes it is almost an inevitability that the eurozone and the United Kingdom will slip into a recession.

“The European Commission’s economic sentiment indicator took a dive in July, with forward-looking indicators pointing to an economic contraction in the second half of the year. Meanwhile, inflationary pressures are starting to soften, albeit only gradually,” Peter Vanden Houte, the chief economist of the eurozone at ING, wrote in a note.

Elevated food and energy inflation is affecting the economy as consumers are tapped out and businesses slow down activity. The only bright side is that cooling demand might be what cures inflation, which would be at the expense of the economy.