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

two thirds 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 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.

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 US 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 taken 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 half way 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 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.

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 internalize every piece of good news as

a favorable factor for them.

For them, inflation is top of mind and is really

underpinning, um, 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 are 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 them, 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 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, 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 to different concepts.

And so 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, oh, 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 partizan 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 favorable

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 partizanship 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 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.

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 November's US

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 gut 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, um, 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 the aisles of Walmart because it is

high frequency purchases like food, the family