Did you watch the debate this past week?
The very first question was about the economy and the inflation we’ve experienced. Objectively, looking at the data, the economy is doing great! We’re setting records for low unemployment and high labor force participation. More people are working, we’ve been adding jobs in higher-paying sectors of the economy, consumers have been going out and spending. The bottom 80% of the income distribution has seen about the same or higher real income growth (even after taking into account inflation) in 2019-2022 as they did in 2016-2019 (see Exhibit 1). And yes, inflation has been high, but it’s cooling and getting closer to the Fed Reserve’s 2% target.
But we don’t feel like we’re doing better. Why is that? Why is there this disconnect between how we’re objectively doing and how we’re subjectively feeling? Here’s how economists tend to think about what’s going on:
1. “Reference dependence” – When we think about how we’re doing, we compare ourselves now to ourselves at another point in time. And we also compare ourselves to our “peers”. These are going to be some difficult comps.
In 2021, most of us were doing great: vaccines had just rolled out, the labor market was rebounding, employers were jostling for workers, we were flush with pandemic savings, mortgage interest rates were low, we had paid-off our credit card balances, student loan repayments were still in moratorium, we had enhanced SNAP benefits, enhanced unemployment insurance, enhanced child tax credits, we hadn’t seen an inflation spike yet, we had managed to cut child poverty in half (see Exhibit 2). It’s going to be hard to compare ourselves to the 2021 post-pandemic euphoria and think we’re better-off in 2024 than we were in 2021. Even objectively, most of us are not better-off today than we were in 2021, even if we’re better-off than we were in 2019. When we’re glum about how we’re doing now, it’s because we know how great things can be.
Then, “Keeping up with the Joneses” has taken on a whole new meaning in the world of social media. Back when we compared ourselves to our neighbors and close friends, we could see both the good and the bad. Perhaps our neighbors had just bought a new car, but on a warm summer evening with open windows, we could also overhear their arguments. No ones’ lives are ever perfect. In the world of social media, things look a lot more perfect than they really are. People post about their amazing meals, their vacations, the events they go to. People don’t post about day-to-day drudgery even though we all experience it. Our “reference dependence” is based on false impressions of how others are doing. In Numerator data, those who tend to get more of their information from social media also tend to be more pessimistic (see Exhibit 3).
In a recent global survey on happiness, Americans no longer rank in the top 20 of the happiest countries, and the score was brought down by how unhappy younger consumers are feeling. Objectively, we can see in the data that younger consumers today are doing better for their age than every generation before them. This is one of the hallmarks of the US: every generation is still doing better than the ones that came before, even if we don’t feel that way (see Exhibit 4).
A final point on reference dependence: consumers understand levels, not rates of change. A rate of change is a first derivative (remember Calculus?). How well does the average American consumer understand first derivatives? Price levels are much higher than what we’re used to. Even if groceries are as affordable today (because our incomes have gone up more than the price of groceries), they’re still more expensive. Even though price levels remain high, the rate of price changes (the first derivative) has come back down to normal levels (see Exhibit 5). But that’s not how consumers tend to process information. Eventually, over time, we’ll have a new reference point and we’ll be accustomed to the higher price levels. We’re not there yet.
2. “Loss aversion” – 2020 was horrendous. Many of us lost jobs, lost loved ones, and missed out on life opportunities. The pain of losing is about twice as powerful as the pleasure of gaining. FOMO is real! Even though we’ve gained a lot since the end of the pandemic, the pandemic was still scarring. And now, the possibility of a slowing economy and job losses looms large. The unemployment rate has been increasing from a low of 3.4% in April 2023 to 4.0% currently, and the Federal Reserve expects it to reach 4.2% by the end of 2025. Many of us experienced job losses in 2020, and we know how painful and stressful it can be. The prospect of job losses is worrisome even though the labor market is objectively doing well.
3. “Salience bias” – What’s actually happening is often different than what we hear about. Take the labor market, for example. Layoffs have occurred at some high-profile companies in high-profile sectors that get a lot of attention. There has been substantially more hiring than layoffs, but we don’t hear about hiring in sectors like healthcare or at less well-known companies as much as we hear about layoffs in tech and at high-profile firms (see Exhibit 6). There’s a bias for what’s salient, and what’s salient is often the bad news, not the good news.
(For more information on reference dependence, loss aversion, and salience bias, see here: https://www.marketplace.org/2024/06/25/economic-data-glum-vibes-vibe-cession-pessimism/)
Does it matter that consumers feel so glum? Normally, the answer is “yes” because the “vibecession” can turn into a recession if consumers are feeling bad about the future and start making cuts today in preparation for worse things to come. Then we get into a vicious cycle where people think the future is going to be worse, so they start cutting back, and then businesses see declining sales and start cutting back on workers, and then people lose their jobs and they were right to have been concerned and make cuts in the first place. This is a self-fulfilling prophecy. What has prevented this self-fulfilling prophecy is that even though consumers don’t feel great about the economy, they have continued to spend anyway, powered by pandemic savings and a strong labor market. But consumers have depleted their pandemic savings, the labor market is slowing back to normal, and the echo-chamber of negativity in an election cycle can be deafening.
American Consumer 