The K-Shaped Economy Isn’t Just the New Stagflation—It’s Worse

As Trump’s first year back in office comes to a close, it is clear most voters think the economy is in poor shape and that prices for essentials have become unbearable. This pessimism isn’t limited to Democrats and disgruntled independents. According to a new Politico poll, over a fifth of self-identified MAGA Republicans think Trump’s tariffs, his main policy to restructure the economy and reshore industry, are causing short- and long-term harm.

Headline-grabbing holiday shopping numbers, boosted by the proliferation of “buy now, pay later” plans, are unlikely to reflect a more hopeful outlook for 2026. While consumer sentiment has lifted slightly since November’s notable drop, it is doubtful holiday spending can be taken as a useful gauge of how Americans feel about their economic security, considering the blow to household finances that is about to be dealt to millions by the expiration of Affordable Care Act subsidies.

Unsurprisingly, Trump’s team remains bullish about growth. While Trump has conceded that voters aren’t happy in a new interview with the Wall Street Journal, he and his advisers have mostly swatted at news that underscores affordability is the public’s central issue. Still, a steady drumbeat of discouraging economic trends on top of elevated grocery prices and health care costs clarifies that consumer distress isn’t part of the episodic “vibecession” or, as Trump more often asserts, a crisis fabricated by Democrats. Excluding the Covid shock of 2020, layoffs for the year have reached their highest level since 2009. The share of jobless Americans suffering long-term unemployment has ticked past twenty-five percent. Manufacturing has contracted for nine consecutive months, undercutting Trump’s boasts that international firms are lining up to invest domestically. Although still below pre-pandemic levels, foreclosures have increased this year at the same time that building permits have all but stalled and 75 percent of prospective buyers can’t afford what’s on the market.

This is not the stuff of a “new roaring Twenties”—at least not for paycheck-to-paycheck America. The so-called K-shaped recovery, which economists initially warned of as the economy reopened after the pandemic, has indeed transpired, resulting in an economy even more bifurcated than last decade’s. That is, the country is undergoing a marked divergence between very wealthy asset holders and those with declining purchasing power and increasing indebtedness, with little else occurring to signal it is in any respect transitory.

The K-shaped dynamic should concern all policymakers and elected officials intent on avoiding the anemic conditions of post-Brexit Britain, Italy, and Europe’s many other stagnant economies. Primarily due to Trump’s extremely injudicious use of tariffs, economists have warned nearly all year that America is lurching toward a stagflationary environment resembling that of the 1970s. But the underlying fundamentals that have made the K-shaped economy possible suggest our current trajectory could prove comparatively worse. The post-Covid era has introduced novel financial pathologies and algorithm-driven squeezes that most experts and policymakers, fixated on standard barometers of “good times,” seem determined to minimize. Indeed, despite abundant signs working families are treading water, Washington seems content to do nothing but watch Americans perpetually borrow their way out of pinched budgets.

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The K-shaped economy can be summarized as the latest demoralizing phase in a decades-long trend toward greater inequality. Still, what makes inequality post-Covid that much harsher than in prior decades is the extent to which middle- and working-class “thrift”—neither pleasant nor good for growth—has become harder to pull off. In lean times, every household tottering on the brink has had to resort to austere choices to keep its bills from outpacing income. Now, however, it has become commonplace for households that are stable on paper to feel as though they are hostage to an unending game of Russian roulette.

Instead of scoping out a steady stream of deals and sales—once the go-go promise of a digitalized market that was supposed to teem with competition—one must dodge insidious markups while avoiding any kind of costly emergency. The “gamification” of the economy, typically associated with beguiling inconveniences like surge pricing on rideshare apps, has seeped into every type of transaction, creating market pressures and “incentives” that leave few businesses and consumers any real way of opting out.

This is a situation in which the mainstream economics profession increasingly grasps for relevance. Over the last few decades, the regressive shift in income distribution and, perhaps more importantly, how disposable income is used by nominally middle-class households has diminished our ability to judge traditional macroeconomic indicators with much confidence. But the disconnect between how economists evaluate the economy and how ordinary Americans navigate it has become far more pronounced in the pandemic’s aftermath.

Take the employment rate—probably the most important metric to social democrats besides the Gini coefficient, and one which also happens to animate Trump. Normally an economy with several years of unemployment below five percent and modest wage growth would be considered fairly healthy, assuming roughly 50-60 percent of workers’ paychecks wasn’t going to housing and food. Yet in many parts of the country—not just coastal hubs with perennially tight housing markets such as San Francisco, New York City, Boston, and Seattle—regular workers and middle-class families are spending this much on the bare essentials. Even worse, they are increasingly financing these non-discretionary monthly bills as though they were big-ticket items—a practice Americans could have scarcely imagined a generation ago.

The precarious state of Americans’ financial health is bound to be exacerbated by soaring health care costs. Come January, the tsunami of exorbitant health insurance premiums, which in many cases are set to double absent a deal to extend ACA subsidies, virtually assures one of two patterns. We can expect either a tremendous softening in spending on recreation, “self-care” services, entertainment, travel, dining out, and the extracurricular activities of school-age kids—meaning lasting repercussions in sectors that disproportionately support local entrepreneurs, decent wages in big metros, and freelance professional opportunities—or a phenomenal spike in borrowing, and thus higher credit card interest rates, to simply meet existing needs.

Neither situation may prove catastrophic right away. Still, the former would significantly raise the odds of a recession next year, contrary to the Fed’s cautiously optimistic growth forecast. While layoffs at large corporations are the most obvious warning sign of a downturn, one can be grimly certain that when smaller businesses reduce operations, pare back staff, and cut hours for remaining employees, economic pain and uncertainty are spreading across the system. The alternative—in which households earning less than, say, $100,000/year hold their noses and take on more debt—would probably delay a harsh contraction, albeit by propping up the system through unsustainable choices. One way or another, stunted demand among the 3rd and 4th income quintiles, forced by escalating credit card repayments and the likely increase in out-of-pocket health care fees, will bring down the curtain on a recovery whose foundations have always been chimerical.

There are few discernible ways in which the ensuing pain might be mitigated, at least under the current administration and Republican Congress. To begin with, it is dubious that the GOP tax cuts, which go into effect next year, are going to even modestly ease middle-class financial burdens. The Yale Budget Lab estimates that two-thirds of American households will receive less than a $500 tax cut, or barely a quarter of what the average two-parent household is expected to spend on holiday shopping. Energy deregulation, which is increasingly touted by the right as the best way to curb inflation besides politically unpalatable interest rate hikes, is also unlikely to help. While Republicans anxious about the midterms might take comfort in the fairly low cost of gasoline, the surge in the cost of natural gas for heating and cooking, as well as the overall jump in electricity prices due to the energy demands of AI data centers, is bound to neutralize that minor benefit to working families and small businesses.

Other tinkering largely leaves price cuts up to market players that have grown accustomed to padding their profits. Tariff relief on select foodstuffs, a rare admission by Trump that the breadth of his trade regime is deeply unpopular, depends on the motivation of importers and distributors to pass on savings precisely when working-class households are about to scale back on premium goods and devote more of their budget to packaged staples, produce, and other basic commodities.

Bigger quick-fix remedies that were first introduced during the pandemic certainly beckon. Last month Trump seemed to commit more concretely to a $2000 tariff rebate in 2026, an idea he has repeatedly floated to quell consumer angst. But even if he managed to cajole Congress to follow through on this proposal, the refund would in most cases be swallowed up by less than one month’s health insurance premium.

This highlights an inconvenient fact about fiscal policy’s diminishing impact on growth and consumer confidence. The problem that Washington in general is afraid to concede is that one-off fiscal transfers, even “sizable” ones, have become a drop in the bucket of necessary annual household expenditures. That is unfortunate enough, but what is more pertinent here is that by design such transfers don’t fundamentally alter the price-making power embedded in our data-mined economy. Indeed, whether framed as “stimulus” or “relief” checks, the effect is the same if there is no mechanism to contain non-wage-push inflation, which is the kind of price growth we have been seeing since Covid initially and temporarily contracted the labor supply. Making the matter seemingly more intractable, large tariff rebates, in addition to regressive tax rates and multi-billion agriculture bailouts, run the risk of worsening inflation by ultimately increasing the interest payments on U.S. national debt.

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Of course, the Trump administration is putting a lot of stock in a much-anticipated, AI-assisted breakthrough in productivity to buoy the public mood and retire stories about the affordability crisis. Perhaps, too, a downturn driven by spiraling health care costs or another blow to purchasing power won’t come to pass. Yet even if middle-class professionals are, against predictions, spared a wave of AI-induced layoffs and growth picks up beyond the AI sector, perceptions of the economy may not improve to Trump’s liking.

It’s easy to understand why. As illustrated by the well-documented disparity between productivity gains and wage growth that gathered pace in the 1980s—a source of mounting discontent whose impact could only be deferred until the Great Recession through lower cost imports, a stronger dollar, and the threat of further outsourcing—growth in and of itself doesn’t inherently eliminate the factors that fuel economic anxiety and downward mobility. Fundamentally, if wage growth isn’t generating significantly more disposable income for either savings or greater material comforts, and fixed monthly expenses and groceries are steadily increasing without any perceptible non-monetary improvement in consumer welfare, then GDP growth will fail to sustain Americans’ ebbing faith in democratic capitalism.

It would be a mistake, then, to assume growth or a tightening labor market will simply alleviate today’s economic pessimism. As Biden’s advisers discovered, it is entrenched, the consequence of cumulative pressures that neither targeted anti-poverty programs nor tax cuts can permanently remove. Ultimately, such discontent will become a fetter on development in its own right, as fewer Americans will believe they can afford to start a family, buy a home, or take professional risks that build wealth or contribute to innovation. Policymakers who understand the implications for our already warped social contract must not hesitate to take their case to the public.