The Consumer Sentiment Index
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. Its 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 two thirds of GDP. But theres. A pervading sense of disconnect between the overall economic picture and how people feel about the economy.
Discrepancy Between Perception and Reality
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 theres a fair bit of evidence that, bit by bit, things are getting quite a little bit better.
Conflicting Views
It’s not just consumer sentiment levels that have been at odds with strong economic data. In a 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 it was better for 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.
Consumer Sentiment vs Economic Reality
So why hasn’t consumer sentiment matched up with the economic reality? 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.
Disconnect and Factors Behind It
Research has shown that consumer sentiment 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.
Impact on US Presidential Election
I think what 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, the official unemployment rate, or the official inflation rate. One reason for this disconnect is because it’s not affecting the average consumer the same way that it’s affecting the global economy.
Contrast Between Views and Data
Beyond consumers not reaping the rewards from the strong economic data, their views of the economy stand in direct contrast with the data itself. This issue could play an outsized role in this year’s US presidential election.
The Perception of Inflation
In a Wall Street Journal poll conducted in February of 2024, 68% 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 people. Normal people think in terms of price levels.
Frequency Bias and Consumer Behavior
Consumers are well connected with what’s going on in the macroeconomy, but they don’t necessarily internalize every piece of good news as a favorable factor for them. For them, inflation is top of mind and really underpins a lot of their overall views. One of the problems is that consumers are just useless at forecasting inflation due to something called frequency bias. Economist Paul Donovan argues that consumers tend to forget the price of less frequently bought, more expensive items but are much more likely to remember the price of lower-priced, frequently bought goods.
Composition of Inflation and Consumer Perception
When we look at the composition of inflation, particularly in the United States, prices of durable goods like televisions, furniture, and consumer electronics are falling. However, nobody remembers that fact. Every time you go to a vending machine to buy a Snickers bar, you remember the price has gone up because it used to be one price and now it’s higher. This creates the illusion that inflation is higher than it actually is, contributing to the negative perception of the economy among many Americans.
Stubbornly High Prices
While overall inflation levels have been steadily declining over the past year, the cost of high frequency purchases such as food and gasoline have remained stubbornly high. These everyday expenses, although they may not make up a large portion of our overall spending, have a significant impact on our perception of the economy.
Salience and Accessibility
Items like a cup of coffee or groceries are more salient and accessible in our minds because we purchase them frequently. Every time we make these purchases, we are reminded of the higher prices, leading to a negative perception of the economy. This constant reminder contributes to a feeling that prices are always on the rise.
Reference Prices
For items that we buy regularly, we tend to have a reference price in mind – the price we are used to paying. When the current price is significantly higher than this reference price, it feels more expensive to us. This discrepancy adds to the perception of increasing prices and inflation.
Disinflation vs. Inflation
Back in 2020 and 2021, inflation was described as transitory, with the expectation that it would decrease in the near future. However, what the United States has been experiencing over the past year and a half is disinflation – a decrease in the rate of inflation. While overall inflation levels have been on the decline, the persistence of high prices for everyday items continues to shape Americans’ views on the economy.
Rising Prices
Overall prices are still rising, but they’re generally rising a lot more slowly than they were 12-18 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 $4 is 25%, so it might go up to $5. The price is going up, although it may be going up more slowly than it’s done in the past.
Consumer Expectations
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. So, when they see prices remaining the same or slightly increasing, it creates tension and frustration.
Confusion Between Concepts
The average consumer may be frustrated when they’re going to the grocery store and seeing prices that are the same or slightly higher than they were last year when they’re expecting them to decrease. Economists may say things are improving on the inflation front, but consumers don’t always believe them because they’re hoping for deflation.
Internalizing the Situation
Consumers have been taking a while to internalize the fact that prices may not decrease as expected. The tension arises from the disparity between what economists are saying and what consumers are experiencing in their everyday purchases. The emotional desire for prices to go down contributes to the ongoing feeling of unease regarding the economy among many Americans.
Partisan Divide
One of the reasons why many Americans still feel bad about the economy despite strong data is the growing partisan divide in the United States. Democrats and Republicans often differ in their views on the economy, with consumers belonging to the party in control of the White House tending to have more favorable levels of sentiment. This divide can significantly impact how individuals perceive the state of the economy, leading to mixed feelings and sentiments.
Consumer Sentiment
Registered Republicans currently hold a very bleak view of the economy, according to sentiment polls, while registered Democrats are relatively optimistic. This partisan gap in consumer sentiment is larger than other demographic differences, such as education level and age. The differing views of consumers based on their political affiliations can contribute to the overall negative sentiment towards the economy, despite positive economic data.
Price Stabilization
Although many prices are starting to stabilize, consumers are still feeling the impact of the high prices that were prevalent 18 months ago. Many individuals have a benchmark for what they consider a fair price, and anything above that benchmark can lead to dissatisfaction and a negative perception of the economy. This lingering memory of past high prices can overshadow current economic improvements, contributing to the overall sense of economic unease.
Adjusting Consumer Expectations
Consumers may still be coming to grips with the changing economic landscape and adjusting their expectations accordingly. While data may show positive trends, individual experiences and perceptions can be influenced by various factors, including partisan beliefs and past economic conditions. As consumers navigate these complexities, there may be a continued sense of uncertainty and unease regarding the economy, despite strong economic indicators.
Rising Prices and Consumer Perception
The idea that we’re in a new normal. We’re not going back to the way things were. 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. The perception of high frequency price increases is going to diminish and that will make people feel a bit better about the economy.
Consumer Sentiment and Economic Reality
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. This will also help to support sentiment a bit. Whether the gap between consumer sentiment and economic reality narrows could play a pivotal role in determining the outcome of November’s US presidential election.
Uncertainty and the 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. Voters trust their gut when it comes to voting very often. That’s why things like high frequency prices matter a lot to the election.
Perception vs. Reality
Despite strong economic data indicating growth and stability, many Americans still feel pessimistic about the state of the economy. This can be attributed to the perception individuals have regarding their own standard of living. Even if data shows improvement, if individuals believe their quality of life has not improved, they will continue to feel bad about the economy.
Inflation Concerns
Another factor contributing to the negative sentiment towards the economy is the lingering concern about inflation. Even though inflation rates may be under control, the fear of rising prices can lead to a sense of insecurity and dissatisfaction among consumers.
Impact on Political Views
These negative perceptions can have a direct impact on political views and preferences. If individuals feel financially strained or believe that the economy is not performing well, they are more likely to express dissatisfaction towards the ruling party. This can sway election outcomes and influence policy decisions.
Consumer Behavior
High-frequency purchases, such as grocery bills and everyday essentials, play a significant role in shaping how individuals perceive their economic well-being. The cost of basic necessities can have a direct impact on how people feel about their financial situation and overall quality of life.
Implications for the Future
As the United States approaches a major election, the sentiments of Americans towards the economy will play a crucial role in determining the outcome. The gap between strong economic data and individual perceptions highlights the complex nature of consumer behavior and political decision-making.