Image Source: Pixabay

Consumer sentiment has dropped sharply since the first of the year, according the University of Michigan’s survey. The Conference Board’s Consumer Confidence measure did also. Inflation is probably the culprit.

President Biden’s supporters have argued that people should enjoy the current economy. Alan Blinder’s view ran with the headline, “The Economy Is Good. Why Don’t People Know It?” The argument that people ought to be happy includes unemployment of just 4.0%, well below the historical average. And it’s not just a case of discouraged workers not counted as unemployed. The employment/population ratio of 60.1% is nearly a percentage point higher than average.

Jobs turn into income. Disposable income adjusted for inflation has increased by a full percentage point over the past 12 months. Past stimulus checks that were saved enabled people to increase their spending 2.6% after inflation adjustment.

A team of economists including Larry Summers published research that borrowing costs tell a large portion of the study. They had to massage the data mightily, though, as the simple correlation of interest rates to consumer attitudes is very small. In a multiple-causation analysis that includes employment and inflation, interest rates seem to improve consumer attitudes, not worsen them. Nonetheless, older research (such as the DRI economic model from the 1980s) had also found higher interest rates negatively impact consumer sentiment.

Global crisis and domestic turmoil can rock consumers. We see bloodshed in the Middle East, war in Ukraine and saber-rattling in China. Voters express disgust over the choices they see in the upcoming presidential election, and ongoing protests that sometimes turn violent contribute to angst.

Nonetheless, inflation is probably the major story behind weak consumer sentiment. We economists prefer to look at inflation-adjusted incomes and expenditures, but that’s not how consumers see things. They generally don’t see their wage gains as part of inflation. Average hourly earnings rose 7.0% in the 12 months leading up to March 2022. Workers probably thought they deserved their pay raises. Who wouldn’t?

But the high inflation back then, 8.5% on the Consumer Price Index, probably felt like theft. The pay raise was deserved, but the inflation felt like a separate act of injustice. In fact, there was some injustice, as the inflation cut the purchasing power of workers’ pay all though 2022. But since May 2023, average hourly earnings have increased faster than inflation.

Consumers may also have some nostalgia for old prices. They remember what a pound of ground beef used to cost or a loaf of bread. The news may report that inflation is down, but consumers see higher prices. The math is fairly simple: seven percent inflation one year and three percent the next year come to ten percent plus a bit more for compounding. Prices don’t go down, even if the inflation rate declines.

Weak consumer attitudes could be called myopia or ignorance, but it’s what they feel. Sentiment is not as low as in recessions or the pandemic, but both of the major surveys show weaker attitudes than in the years immediately prior to 2020.

The effect of these feelings will probably be to dampen discretionary spending relative to the path that expenditures would be on based strictly on purchasing power. Staples—bread and milk—will probably sell just as well, but desserts and frills not so much. Investments will probably tend toward less risk.

Weak consumer attitudes may also impact the upcoming presidential election, but a great deal more enters into voting decisions and there’s plenty of time for preferences to shift.

More By This Author: