A Blog by Jonathan Low


Nov 9, 2021

How the Psychology Of Inflation Became Worse Than Its Economic Impact

The reality is that relative to the growth of the economy and to the lower inflation of the past few years, it is not extraordinary. 

But that is not the perception, and it is the latter which is influencing both attitudes and behavior about post-pandemic economic well-being. JL 

Justin Fox reports in Bloomberg:

The U.S. economy is growing at a pace not seen in decades, with domestic product growth of 5.7%. Employment is up by an average of 655,500 over the past six months. The unemployment rate is down to 4.6%, and wages have been rising. The S&P 500 Index is up 37% over 12 months, its best performance ever in the year following the election of a new president. Yet 65% of respondents thought the U.S. economy was “poor.” Consumer prices have risen fast over the past six months and there’s evidence of growing partisan bias in consumer sentiment, with Americans judging the economy more favorably if the person they voted for is president.

The U.S. economy is growing at a pace not seen in decades, with economic forecasters surveyed by Bloomberg expecting real gross domestic product growth of 5.7% this year and 4% in 2022. Eighteen months into the post-pandemic economic recovery, nonfarm payroll employment grew by an impressive 531,000 in October and is up by an average of 655,500 over the past six months. The unemployment rate is down to 4.6%, and wages have been rising briskly. Oh, and the Standard & Poor’s 500 Index gained 37% over the 12 months ending Nov. 3, its best performance ever in the year following the election of a new president.

Yet Americans’ attitudes about the economy seem to be quite negative. The Gallup Economic Confidence Index was almost as low in October as it was amid the pandemic lockdowns of April 2020, and the University of Michigan Consumer Sentiment Index is even lower. An October poll by the The Associated Press-NORC Center for Public Affairs Research found that 65% of respondents thought the U.S. economy was “poor.” Exit polls in Virginia last week rated the economy as the top issue of concern.

It’s not all negativity: A record-high 74% of respondents told Gallup in October that this is a good time to find a quality job, and 65% told AP-NORC pollsters that their personal financial situation was good. The Conference Board’s Consumer Confidence Index rose in October and, while lower than before the pandemic, is higher than at any time between 2001 and 2017.

Still, the overall mood does seem more appropriate for a slowdown than for boom times. So which are we experiencing? Is the economy doing as well as most of the data seem to indicate, or do gloomy regular Americans know something that the economic indicators and economic forecasters don’t?

One theory is that sentiment measures pick up signals that only appear in the hard data months or even years later. Economists David G. Blanchflower and Alex Bryson declared in a National Bureau of Economic Research working paper released last month that “downward movements in consumer expectations in the last six months suggest the economy in the United States is entering recession now (Autumn 2021) even though employment and wage growth figures suggest otherwise.”Since they wrote those words, the employment and wage growth figures have continued to suggest otherwise, so I’m guessing that the recession call will turn out to be wrong. I can also think of at least three reasons why current economic sentiment, while not wrong — how can sentiment be wrong? — may not be as good a guide to what’s going on with the economy as it has been in the past. Two of them should fade away soon, but a third may not.

1. Inflation is a pain but not a predictor

Consumer prices have risen faster over the past six months than at any time since the early 1980s. The rate of increase has already slowed markedly in the month-to-month data, and to my mind the appropriate historical parallels here are the short-lived inflation spikes that followed World Wars I and II and not the drawn-out stagflation of the 1970s and early 1980s. But regardless of what happens next with inflation — which is what most of us in and orbiting around the financial sector are focused on — the reality for consumers is that lots of things cost more than they used to, and some things cost lots more. In the 1970s, economist Arthur Okun constructed what he called a “misery index” by adding together the inflation rate and the unemployment rate. Measured this way, misery is currently low by 1970s standards but higher than it’s been for most of the past quarter century.

That pain is real, and deserves to be taken seriously. But both the unemployment rate and the inflation rate are lagging economic indicators, meaning the misery index looks backward, not forward. Unless we are in for a sustained 1970s-style inflationary wave or a recession, it will fall a lot over the next year. 

2. It’s messy out there

Most economic trends seem to be heading in the right direction. But the data are really noisy! The U.S. economy grew at a 6.7% annualized rate in the second quarter, a 2% rate in the third — and the Federal Reserve Bank of Atlanta’s GDPNow is currently pegging fourth quarter growth at 8.5%. Labor productivity (output per hour worked, a key driver of long-run improvement in living standards) has been on an upward trend since before the pandemic and there’s lots of reason to think that will continue, but third quarter numbers released last week showed a 0.5% year-over-year decline and 5% annualized quarterly one.

Supply chain disruptions and the delta wave of Covid-19 explain a lot of this stop-start activity. They also help explain the sour mood. The sharp drop in consumer sentiment over the summer, Michigan survey director Richard Curtin said in August, “reflects an emotional response, mainly from dashed hopes that the pandemic would soon end.”

There could be more dashed hopes in the future, and not just from Covid-19. There’s no guarantee that the Federal Reserve and other central banks around the world will successfully manage their retreat from extremely expansive monetary policy. The inflationary episodes following the two world wars were both followed by long periods of prosperity, but after World War I there was a steep-if-short depression caused by ill-timed Fed rate hikes first. The retreat from fiscal stimulus brings risks, too, with the Brookings Institution’s Hutchins Center Fiscal Impact Measure forecasting that government retrenchment will subtract about 2.5 percentage points from U.S. GDP growth next year. Bull markets in meme stocks, cryptocurrencies and, well, the S&P 500 could also end in tears, causing collateral economic damage.

In short, it’s not unreasonable to worry about bad things happening. Plus, even a lot of the good things don’t feel great. The tight labor markets that are driving up wages may also be making it hard for your favorite restaurant to stay open. High demand means shortages keep popping up all over the economy.

3. The information ecosystem has changed

There’s evidence of a growing partisan bias in consumer sentiment, with Americans judging the economy more favorably if the person they voted for is president. This may make it harder to reach a sustained consensus that economic times are good — something that last happened in the late 1990s and early 2000s. There could also be partisan asymmetry in how economic perceptions are formed. For example, the legacy media now consumed mostly by Democrats and independents may well be biased against Republican politicians, but they’re even more biased in favor of novelty and conflict. The conservative media favored by Republicans are more overtly partisan. So what we’re getting right now is relentless hammering on inflation and other economic sore spots from conservative outlets that were mostly economic cheerleaders during Donald Trump’s presidency and … only moderately less-relentless attention to them in the mainstream media. Then there’s the wide array of emergent media subcultures that aren’t partisan but do have a habit of knocking the status quo, as with crypto enthusiasts warning of hyperinflation.

This is not a plea for a return to the more centralized way economic news was produced and consumed 25 years ago. There’s vastly more high-quality economic information and analysis available now to those who want it, and the media’s overall turn from manufacturing consent to manufacturing dissent has its positive aspects as well as negative ones. But one upshot may be that people’s views of the economy are revealing increasingly more about them and less about the economy. In an article published in the Review of Economics and Statistics article in April, Atif Mian, Amir Sufi and Nasim Khoshkhou documented large shifts in economic expectations along partisan lines after the 2008 and 2016 elections, but also report that “administrative data on spending shows no effect of these shifts on actual household spending.”


In a somewhat related vein, Americans tend to think presidents have more control over the economy than they really do. That’s nothing new, but I get the impression that some of today’s economic pessimism has to do with people downgrading their view of President Joe Biden’s competence in the wake of the summer’s resurgence of Covid-19 and messy U.S. withdrawal from Afghanistan. Frequent chaos in the Trump White House didn’t prevent the economy from performing well during his tenure until the pandemic hit, though, and I doubt Biden’s management skills or lack thereof will determine the pace of economic growth over the next couple of years.

Of course, if GDP really does rise 5.7% this year and 4% next, and job growth continues, at least some Americans will shift their opinions of Biden yet again. More generally, one has to expect that data and sentiment will converge somewhat as the economic signals become more consistent. But complete agreement between the two may be a thing of the past.


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