Why many Americans still feel bad about the economy despite strong data

Take a moment to consider your financial situation. Are you better or worse off financially than you were a year ago? How about a year from now? Where do you see the country headed in the next five years? These are just some of the questions used by the University of Michigan to calculate the Consumer Sentiment Index, an economic indicator measuring how people feel about the economy. It’s a measure that we can compare over time and get a pulse on the attitudes of consumers, which is important given that consumer spending is over 2/3 of GDP. But there’s a pervading sense of disconnect between the overall economic picture and how people feel about the economy despite declining inflation. A healthy labor market with record low unemployment, as well as stocks that remain in a bull market. Consumer sentiment remains below pre pandemic levels. When people are sort of asked almost anything about the economy, they react in a very sort of visceral way that everything is lousy. Even though there’s a fair bit of evidence that bit by bit things are getting quite a little bit better. And it’s not just consumer sentiment levels that have been at odds with strong economic data. In the New York Times Siena College poll conducted in February, 40% of respondents said the economy was worse than it was a year earlier, versus only 23% who said I was better. Consumers, When they tell us that they’re feeling like the economy is average, that is their experience, because their experience is not necessarily being driven by macroeconomic indicators. So why hasn’t consumer sentiment matched up with the economic reality? And what are some of the factors behind the disconnect and why the issue could play an outsized role in this year’s U.S. presidential election? The surveys of consumers at the University of Michigan have been measuring consumer sentiment since 1946 and on a monthly basis since 1978. It’s based on a number of questions about personal finances, business conditions as well as buying conditions for durables, both right now and for their expectations for the future. And taking together what research has shown is that it captures very well how people feel about the economy which feeds into how they make economic decisions going forward. Current sentiment levels released in April of 2024 show that sentiment has remained steady since the start of the year, hovering at around the halfway point between all time low levels from June of 2022 during the height of inflation and pre pandemic levels. I think what we we can definitely say about how consumers feel about the economy is that their impressions of the economy aren’t being driven necessarily by the official GDP release, by the official unemployment rate or the official inflation rate. And so one reason that you see this disconnect is because it’s not affecting the average consumer the same way that it’s affecting the global economy. But beyond consumers not reaping the rewards from the strong economic data. In some cases, their views of the economy stand in direct contrast with the data itself. In fact, in a Wall Street Journal poll conducted in February of 2020, 468% of Americans surveyed said inflation had moved in the wrong direction in 2023, despite data showing otherwise. People don’t tend to think in terms of inflation. Economists do, but economists are not normal. Normal people think in terms of price levels. Consumers are, I would say, well connected with what’s going on in the macro economy. But they don’t necessarily internalise every piece of good news as a favourable factor for them. For them, inflation is top of mind and is really underpinning a lot of their overall views. So one of the problems that we’ve got is consumers are just useless at forecasting inflation, I’m afraid. And that’s because of something called frequency bias. In an op-ed for the New York Times, economist Paul Donovan argues that while consumers tend to forget the price of less frequently bought, more expensive items, they’re much more likely to remember the price of lower priced, frequently bought goods. And that’s a real problem at the moment, because when we look at the composition of inflation, particularly in the United States, durable goods prices, so televisions, furniture, consumer electronics, they’re falling. But nobody remembers that fact. However, every time you go to a vending machine to buy a Snickers bar, you remember the fact that that price has gone up because it used to be this price and now it’s this price. And so that sort of sticks in your mind and that creates this illusion that inflation is higher than it actually is. While overall inflation levels have been steadily declining over the past year, the cost of so-called high frequency purchases, namely food and gasoline, have remained stubbornly high. Even though a coffee or the things that we buy at the grocery store on an absolute level for each individual item may not compose that much of our spending, it is more salient and accessible in our minds because we do it more readily. Every time I go and buy a cup of coffee, every time I buy a chocolate bar, I am being reminded that the price level is higher and that just sort of sentiment sticks in your mind and creates this negative perception. Additionally, because we do them more regularly, we’re more likely to have what we call a reference price in our mind for that. When it’s something that we buy on a very regular basis, we have a more solid idea of how much we typically pay for this good. And so when the current price is significantly greater than that, it feels more expensive. And that is what sort of hammers away at your your mental perception of inflation, because every single time you’re being reminded that prices are going up. If we look back on how inflation was described to us back in 2020-2021, people talked about it as being transitory and they would use the words, you know, we expect inflation to go down in the near future and they have. So what the United States has been experiencing overall for the for the last year and a half is disinflation. Overall, prices are still rising, but they’re generally rising a lot more slowly than they were 1218 months ago. If you’re going to the store and you’re used to buying milk for $4 and you experience 25% inflation, it would mean that the price would increase by a dollar, right? So a dollar out of those four dollars, 25%. So it might go up to $5. And so the price is going up. It may be going up more slowly than it’s done in the past, but it is still going up. But what the average American hears when they hear that inflation will go down is that the price is going to come back down to what they expected. What consumers want emotionally at least, is deflation. They want prices to be coming down. And so you naturally say, well, you know, prices are going in the wrong direction. So obviously inflation is going in the wrong direction. But that’s confusing two different concepts. And so I I do think that the average consumer is frustrated when they’re going to the grocery store and especially for these frequently purchased goods that they’re seeing prices that are the same or slightly more than they were last year. When they’re expecting that, it goes back down. And that creates, I think, quite a lot of the tension when economists are saying all things are getting better on inflation and consumers don’t really believe economists because they’re hoping for deflation. And so I think consumers, it’s been taking them a while to really internalize that. And they’re continuing to tell us that even though they’ve noticed that inflation has slowed and they expect inflation to continue slowing, high prices still weigh on them. Part of the disconnect can also be chalked up to the growing partisan divide in the US, particularly when it comes to how Democrats and Republicans each differ in their view of the economy. What we’ve seen, historically speaking, is that consumers who belong to the party that’s in control of the White House tend to have more favourable levels of sentiment than consumers whose party is not in the White House. And independents are right in the middle. And that’s exactly what we see at the moment, that if you look at registered Republicans, they have a very, very bleak view of the economy according to sentiment, opinion polls. But if you look at registered Democrats, they’re actually quite optimistic. And this is a gap that’s large. It’s larger than the gap between people with and without a college degree, younger and older consumers. And so there is some partisanship that can explain some of the difference between how the economy is doing and the consumer sentiment. What we’ve got at the moment, of course, is that although quite a lot of prices are now starting to stabilize, people are still remembering what they were 18 months ago and thinking, well, that’s the fair price and this is above that fair price. I think that consumers are still coming to grips with the idea that we’re in a new normal. We’re not going back to the way things work. As incomes increase and people’s buying power increases, it will get less painful to pay those prices. And as we pay them continually over and over again, I think that people will get more used to it, but it’s not something that can change overnight. I think the perception of high frequency price increases is going to diminish and that will make people feel a bit better about the economy. We do eventually reset our perception of what the fair price level is going to be. The longer prices stay stable, even at a higher level, the more used consumers are to those higher prices, and that helps to reset. And that will also help to support sentiment a bit. Whether the gap between consumer sentiment and economic reality narrows could also play a pivotal role in determining the outcome of Novembers U.S. presidential election. This is an exciting year for consumer sentiment because there’s a tremendous amount of uncertainty that we know is going to be resolved by the end of the year, which is of course the presidential election. The fact that this negativism is so pervasive in the face of evidence is fascinating and you know, obviously if you’re Joe Biden, a little bit troubling. Voters trust their guts when it comes to voting very often. And so that’s why things like high frequency prices matter a lot to the election. Because if you believe your standard of living is lower, even if that’s not true, if you believe that inflation is still a problem, you’re likely to be quite negative towards the incumbent party. And given that we have a historically long general campaign period, I think it’s going to be, you know, possibly a bumpy ride for consumers in terms of their views of the economy. And so This is why I think that one could almost say that the the election in the United States in November could be won or lost in in the Isles of Walmart because it is high frequency purchases like food, the family grocery bill that will actually be quite influential to how people feel their lives are going at this point. Given that we’re sort of at a middle midpoint with sentiment, it’s anyone’s game.