The labor market is roaring ahead, wages are rising and inflation is slowing — all key metrics that economists point to as showing a resilient and strong U.S. economy. The problem is Americans aren't feeling it.
The disconnect between gloomy consumers and upbeat economic data has sparked plenty of debate over the gap, with some experts terming it a "vibecession." The idea behind the term is that Americans are basing their economic views on "feelings," rather than on what's actually happening in their financial lives.
For instance, inflation has come down a long way from its 40-year peak of 9.1% in June 2022. But about 3 in 4 consumers in swing states said they believe inflation is going the "wrong way," according to a recent Wall Street Journal poll.
But there may be more than vibes behind Americans' dour views, such as financial pressures that aren't necessarily captured by data like the consumer price index, which measures the pace of inflation. For instance, the CPI doesn't capture the impact of higher borrowing costs ushered in by the Federal Reserve's 11 rate hikes to battle the hottest inflation in 40 years.
In simpler terms, people are shelling out more money for credit card debt and loans, but this increase isn't directly accounted for in the Consumer Price Index (CPI), which focuses on everyday items like food and clothing. Credit card debt hit a record $1.13 trillion in the last quarter, marking the highest level since the Federal Reserve began monitoring it in 1999.
"Certain expenses, like credit card fees, are deliberately left out of the CPI," explained Kayla Bruun, a senior economist at Morning Consult. "This significantly impacts the overall cost of living."
This issue was highlighted in a research paper by former Treasury Secretary Larry Summers in February. Summers and his colleagues pointed out that interest rates on loans have spiked to levels not seen in many years, causing concern among Americans about the expenses of financing significant purchases, such as homes and vehicles.
Consumers are likely to face high borrowing costs for an extended period. Although the Federal Reserve is anticipated to reduce interest rates later in 2024, recent economic indicators and persistent inflation have led some economists to predict that these reductions might be postponed until later in the year.
Recently, a Fed official hinted that the central bank might not lower interest rates at all in 2024, implying that individuals and businesses may not receive much respite in terms of borrowing expenses in the near future.
Inflation and loss aversion
The upcoming release of the latest consumer price index data on Wednesday will provide insight into the pace of inflation. Economists are anticipating a 3.4% year-over-year increase in prices for March, slightly higher than the previous month's 3.2% rate, as reported by financial data firm FactSet.
Despite a decrease from the peak of inflation earlier in 2022, recent data suggests that inflation is holding steady, according to analysis from Morning Consult. The current inflation rate remains above the Federal Reserve's target of 2%, with many Americans continuing to express it as a major economic worry.
While some economists argue that the acceleration of wages surpassing the inflation rate should instill optimism in Americans about the economy, this perspective overlooks the psychological aspect of consumer behavior. Loss aversion, the tendency for individuals to feel the impact of losing something or paying more money more strongly than gaining something equivalent, plays a significant role in how consumers perceive prices, as explained by Bruun.
"Consumers appear to be more sensitive to price increases than they are to the benefits of higher wages, psychologically speaking," Bruun observed. "Our team believes that this phenomenon can be attributed to loss aversion, where the pain of spending money outweighs the joy of earning more."
Furthermore, Americans may be interpreting the current inflation trajectory as negative, despite it actually trending downwards, due to their firsthand encounters with making purchases, Bruun added.
"Consumers are noticing that prices are on the rise. When asked if inflation is up or down from a year ago, most people are aware that prices have increased over the past year. This perception leads them to believe that things are getting worse," she pointed out.
Despite a slowdown in inflation, prices are still climbing, although at a slower rate compared to the post-pandemic surge. Bruun suggested that consumers may eventually adjust to these higher price levels, but it could take some time for that transition to occur.
"As people come to terms with the new cost of goods and realize that they can manage it, we may see a shift in how Americans perceive the economy, bridging the gap between economic data and public sentiment," she anticipated.
