The average American household is feeling pinched. Real living costs are rising far more quickly than wages for most income groups, resulting in a net decline in the U.S. standard of living. Consumer spending is low, and corporate earnings are flat. And people seem to know it. In March 2016, consumer confidence hit a 13-month low; just 42% of Americans reported feeling confident about the economy.

Efforts to stimulate the U.S. economy have been mostly duds since 2008. The wealthiest Americans lost a lot during the Great Recession, but the middle class lost the most proportionately, per research from Stanford University. Wealthy families recovered their lost wealth by 2010, thanks largely to rising asset prices. Poorer families, who tend to own far fewer securities, did not recover so well. The evidence suggests the middle class is not feeling the wealth effect. Government and central bank policy might be the reason why.

Cost of Living Growth Outpaces CPI

According to the Consumer Price Index (CPI), a complex formula from the Bureau of Labor Statistics (BLS), inflation has been flat or very low since the financial crisis in 2008. Measured CPI was just 1.5% per year between 2011 and 2015. This is a very small number, but it does not resonate with many middle-class households feeling the pressure of rising prices.

Wealth management expert Ed Butowsky, fed up with the CPI, developed the Chapwood Index to measure the real cost of living. Butowsky originally wanted the Index to make sure his clients received a sufficient real rate of return. Once he realized the disparity between official statistics and the experience of real people, Butowsky published his findings.

The Chapwood Index tracks approximately 4,000 items purchased by Americans across 50 major metropolitan areas. The 500 most common items are measured for quarter-by-quarter changes and weighted by the percentage of normal income spent on each item. According to this Index, the real cost of living grew nearly 10% per year between 2011 and 2015, not the 1.5% reported in the CPI.

Eight different U.S. cities, all in California, recorded annual increases of at least 12% during the period. Non-Californian cities with the highest rising costs of living included Washington D.C., Chicago, New York and Detroit.

Government Policy Gone Awry

For decades, federal policymakers have stressed the importance of consumer spending and cheap borrowing costs. The Federal Reserve flooded the markets with money faster than productivity could grow, putting upward pressure on prices and cutting interest rates. With rising prices and easy credit, most Americans went into debt. By 2014, close to half of all Americans had more credit card debt than savings.

If you had a lot of money in the stock market, however, you likely did very well under the Fed's policy. Between March 2009 and March 2016, the S&P 500 grew more than 200%. According to the Fed's Survey of Consumer Finances, the median income fell for every 10% group in the United States, except for the top 10%.

Former Fed Chairman Ben Bernanke frequently struck out against critics and defended U.S. monetary policy, often using Fed-friendly platforms such as the New York Times or the Brookings Institute. In a June 2015 article, Bernanke wrote: "Even if it were true that the aggregate economic gains from effective monetary policy are unequally distributed, that would not be a reason to forego such policies." Later in the same article, he admitted: "easy monetary policy raises stock prices and stocks are disproportionately held by the wealthy."

Pointing the finger at Washington, he concluded that "if fiscal policymakers took more of the responsibility for promoting economic recovery and job creation, monetary policy could be less aggressive." Of course, huge stimulus spending increased total U.S. government debt more than $8 trillion between 2008 and 2015. The U.S. debt-to-GDP ratio climbed from 67 to 101%. Using any historical standard, both monetary and fiscal policy were extremely aggressive. Neither worked, at least not for ordinary Americans.

Imaginary Wealth Effect

Ben Bernanke predicted the Fed's policies would create higher equity prices, which subsequently would boost consumer wealth. He stated that wealthier consumers should be more confident and spend more. This is part of a popular economic theory known as the "wealth effect." Consumer spending, this argument asserts, is generated by expected income.

Expected income should be supported by current wealth. Thus, an increase in current wealth, even if it is paper wealth based on asset prices, should boost expected income and spending. According to the circular flow model of the economy, this should produce real growth.

Merely spending money, however, does not increase real productivity. The surest way to increase real productivity is through savings and investments, not nominal spending. The S&P 500 might be reaching new records, which helps wealthy Americans, but productivity is not rising quickly enough to encourage higher wages for everyone else. The result has been low wage growth, high debt, high real inflation and a very frustrated middle class.

Want to learn how to invest?

Get a free 10 week email series that will teach you how to start investing.

Delivered twice a week, straight to your inbox.