Anger is what drives the American economy

Anger is what drives the American economy

As it turns out, the big economic story of 2023 is not the recession, as many expected — but rather the disconnect between consumer sentiment and behavior.

The higher than usual inflation over the past two years is an obvious reason why people are feeling down about the economy. The mystery is why people still act as if their economic situation is good. Inflation-adjusted consumer spending is on the rise: not just above 2019 levels, but above the pre-pandemic trend. In fact, this is largely why US economic growth is exceeding expectations. However, consumer sentiment remains at levels usually only seen in recessions.

All of this raises the question: What’s going on?

Economists tend to believe actions more than words. You can insist that you prefer a vegetarian diet, but if you continue eating hamburgers, we will conclude that you actually prefer a vegetarian diet. So, if you say the economy is bad but you spend as much as you did in 1999, some economists will tend to trust what you do more than you say — and will question the reliability of polls.

These economists argue that data showing a strong economy, including huge consumer spending, implies that people are not being honest about how they feel about the economy. Instead, they align their views with their political preferences. This argument points to the wide discrepancy between Republicans’ and Democrats’ views on the economy, a gap in attitudes that is not matched by a gap in their economic experience.

Although inflation is an obvious pain point in the economy, it has also fallen significantly – from highs of more than 9% last year to 3.7% today. Hopefully it will continue to decline, but the current rate is within US historical norms, and even slightly lower than it was in 2011.

This brings me to another common explanation for the disconnect between people’s anger and their behavior: It’s the prices, stupid.

Economists focus on inflation, which is the rate at which prices rise. Consumers tend to focus on actual prices themselves. The challenge is that even with inflation under control, prices will remain high. This helps explain why 35% of Americans said in May that inflation and rising costs of living were their “most important financial problem.” However, the same inflation also boosted incomes, which rose even after adjusting for inflation. This may explain why Americans continue to spend even as they complain about inflation.

People like to feel nostalgic about the good old days when everything was cheaper. Of course, wages were much lower back then as well, but people rarely feel nostalgic about that. This type of selective memory explains a concept called the money illusion, which is the habit of judging certain transactions based on nominal rather than real values. The illusion of money makes people hate inflation so much, even when it benefits them: it has, for example, contributed to the rise in the value of homes and investment portfolios.

Then there is the illusion of indecision, a combination of selective attention and confirmation bias, which can make it difficult to recognize the reality of low inflation. When inflation is low, as it has been for most of the past three decades, our brains simply ignore it. Now that our brains are alerted to inflation, confirmation bias can lead us to look for it. And when some prices rise, as they always do, this bias makes them more prominent. People end up believing that price increases are more common than they actually are.

    (tags for translation) financial advisor

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