October 8, 2025

“Drove my Chevy to the levee, but the levee was dry…”

-American Pie, 1971

Don McLean’s hit “American Pie” was an anthem for the social and economic turbulence of the 1960s and 1970s. The first time I heard its iconic chorus, it captured the longing for a time when the world felt less divided. It seemed to encapsulate an unease about the future that my parents expressed at the dinner table.

I came of age in the industrial Midwest as layoffs mounted and factories rusted. I watched the middle class shrink as the heartland became the “Rust Belt.”

Some inequality is natural and inherent in a market-based economy. It reflects differences in skill, grit and luck, which sow the seeds of competition. Extreme inequality is not; it triggers discontent, social unrest and is more corrosive than conducive to growth.

We are already seeing the effects of increasing inequality. Consumer attitudes fell again in August and September, despite an economy that looks stronger than just about anyone expected for the third quarter.

Concerns about inflation and the labor market are elevated, a combination we have not seen since the 1970s. The emerging stagflation is not the same but evokes a visceral response. Higher prices at the grocery store are hard for households to swallow.

The outliers are those who make over $200,000 a year and have large stock holdings. They are more optimistic about the economy. Anything that shakes their confidence could tip the apple cart.

Add a government shutdown and consumer attitudes could further sour. The 35-day shutdown of 2018-19 was disruptive. Consumer spending plummeted in December 2018; it took three months to regain ground lost.

This edition of Economic Compass takes a closer look at income and wealth inequalities, how those shifts are reshaping the economy and the risks to growth. The economy is becoming more dependent upon the most affluent to keep spending and is more susceptible to stock market corrections.

Special attention is paid to the challenge these shifts pose to the Federal Reserve. We are still expecting the Fed to cut short-term interest rates twice before year-end. A prolonged government shutdown would increase those odds, while a quick resolution lowers them.

The shutdown alone could shave 0.2% from real GDP growth per week but losses are nonlinear. Efforts by the administration to freeze spending and implement more permanent layoffs could up those costs.

Chart 2 shows recent work done by Moody’s Analytics on income inequality and shifts in consumer spending. The top 20% of households - those making over $175,000 annually - outpaced overall inflation with their spending since 2021. An even smaller 3.3% of households drove those increases. The bottom 80% have barely kept up with inflation.

The top 20% of earners now account for roughly two-thirds of all consumer spending, a new record. Their cushion on savings has moved up, while the bottom 80% are tapped out. They have depleted their savings, are taking on debt and suffering an increase in delinquencies.

Student loan delinquencies hit an all-time high of 13% in the second quarter. That tops the previous peak in 2013, when the economy was still struggling to recover from the Great Recession. More student loan problems are in the pipeline, which will limit the access those households have to debt.

Chart 3 shows the distribution of wealth and how it has shifted since 2019. The top 10% of households held more than two-thirds of wealth in the US in the second quarter, another record. The top 1% held almost a third. The bottom 50% held only 2.5%, mostly in their homes.

One of the strongest determinants of a child’s future income is the zip code in which they grow up. Affluent zip codes boost children’s access to education and networks necessary to move up in income strata. Poorer families who move to better neighborhoods can shift the economic fortunes of their children.

That is becoming more of a pipe dream. The number of those moving for a job has fallen in recent decades. Homeowners who locked in ultralow rates are not moving, while labor churn has come to a near standstill. 

Only the most affluent can afford to relocate, especially for a job. That means that any boost in income due to job hopping accrues to those households. Rinse, wash, repeat. A cycle of escalating inequality is emerging.

Famed labor economist Alan Krueger dubbed the correlation between income inequality and lower growth prospects “The Gatsby Curve.” It was named for F. Scott Fitzgerald’s 1925 classic novel, The Great Gatsby, which chronicled the inequality that occurred in the early part of the 20th century.

The “curve” is more of a straight line, which maps the performance of economies against the distribution of their incomes. Economies with a more equal distribution of income have tend to perform better than those with more inequality.

High levels of inequality are more prevalent in developing than developed economies. Brazil is an example. It performs worse than an economy such as Denmark, where income is more evenly distributed.

Are we close to a tipping point?

Research by the International Monetary Fund (IMF)and World Bank suggests that the US may be on a precipice. Countries with greater levels of income inequality tend to perform worse.

Specifically, researchers found that countries with a Gini coefficient of 40 or above performed worse than countries with a Gini coefficient less than that. The Gini coefficient is a measure of income inequality.

In theory:

• A Gini coefficient of 0 means perfect equality; everyone earns the same amount of money.
• A Gini coefficient of 100 means perfect inequality; one person has 100% of the income generated.

In reality, all countries lie somewhere between those two extremes. The research simply identifies a possible tipping point, which is 40.

Chart 4 shows the trajectory of the Gini coefficient in the US. The post-WWII drop in inequality hit a wall and reversed course in the late 1970s. It has been on an uptrend ever since, with a brief pause in the late 1990s and during the pandemic.

By 2023, the Gini index was 41.8, the second highest on record. It likely worsened in 2024 and 2025, given the trends. That leaves us looking more like a developing economy and reinforces the case for speed bumps.

The Fed is dealing with a multitude of risks that leave it with few easy choices:

• The bulk of the effects of tariffs are still ahead of us, which ups the risk of higher unemployment and inflation.
• The war on the inflation we endured emerging from the pandemic was never won.
• Service sector inflation could be buoyed by the skew in demand by affluent households.
• Financial market fragilities are rising, sowing the seeds of a larger correction in asset prices.
• The Fed remains “data dependent” in a world devoid of some of the most important data due to the government shutdown.
• Trust in the Fed and other institutions has fallen; any further increase in price levels and deterioration in the labor market will add to that drop.

That has left the Fed cautiously, instead of decisively, cutting rates. We expect the Fed to cut rates two more times this year, but that is not a slam dunk. The pace of rate cuts is expected to be more measured at the start of 2026 and accelerate with a leadership change in the second half.

Jay Powell has been guarded about whether he will stay on the Board of Governors after his term as chairman lapses in May 2026. His term as a governor lasts until January 2028. He wouldn’t be the first to make that decision, but it is unusual.

Risks: The Fed is left in a no-win situation. If it cuts too aggressively, it could stoke a more persistent bout of inflation. If it fails to cut rates fast enough, it could trigger more pain in the labor market.

That is prior to worrying about risks of financial market stability, which is within the Fed’s purview. Consumer debt levels are nothing like what we saw in the years leading up to the Great Recession. Private debt vehicles for small- and middle-market firms are more of a concern.

There are the threats posed by the shutdown itself. The longer it lasts, the more it costs the economy.

Finally, the Fed only controls short-term rates, not long-term rates. Long-term Treasury bond yields have rebounded following the September rate cut much like we saw a year ago. Concern about inflation and a continued rise in debt and deficits are creating a floor under how low bond yields and other rates can go.