How Americans feel about the economy

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AFTER MORE than a year of gloom, Americans are feeling more upbeat about the economy. On October 14th preliminary data from the University of Michigan showed that consumer sentiment improved for the fourth month in a row. The consumer-sentiment index, which fell to its lowest level on record in June, has ticked back up thanks to cooling inflation, and a decline in fuel prices (despite a recent uptick, costs are down by more than 20% since the middle of the year). The results will no doubt be chewed over by investors and market analysts for weeks. Yet for all the interest in measures of consumer confidence, they may not be the economic bellwethers they once were.

Investors have long analysed such surveys for clues about where consumer spending is headed and whether the economy is poised for recession. Historically they have been fairly reliable. A recent paper by David Blanchflower of Dartmouth College and Alex Bryson of University College London found that the two most popular consumer surveys in America—the University of Michigan’s poll and another conducted by the Conference Board, a business-research group—predict economic downturns up to 18 months in advance. Messrs Blanchflower and Bryson found that all six of the recessions that have occurred since the 1980s have been preceded by drops of at least ten points in the two indices.

But in the current business cycle sentiment has been a poor gauge of consumption growth. Between June 2021 and June 2022, the University of Michigan’s index tumbled by more than 40%, even as consumer spending grew by 9.3%. Indeed, Americans’ gloomy mood has been hard to square with economic reality. In June, with unemployment at 3.6%, wages growing by 7% in the past year and bank balances more than 50% higher than they were three years before, the consumer-sentiment index nonetheless sank to its record low—lower than during the oil shocks of the 1970s, after the terrorist attacks of September 11th, in the depths of the Great Recession and at the height of the covid-19 pandemic.

Inflation is largely to blame. For decades, core inflation has been kept below 5% and consumer sentiment has been driven largely by unemployment. Today, although Americans are cheerier than they were a few months ago, high prices continue to weigh on consumer morale, though not by enough to affect actual spending: expenditure is growing by 1.8% year on year. As for why sentiment is lower than it was in, say, 1980 when inflation was above 14%, analysts note that a significant share of the population have only ever experienced low inflation, so the current burst is having a bigger effect than it did on previous generations.

Given the gap between sentiment and behaviour, investors would be wise to focus on what consumers do, not what they say. Although the American economy is facing serious headwinds—including high inflation, a volatile stockmarket and painful interest-rate rises—the labour market is strong. Americans resent paying higher prices. But recent history suggests that, as long as they have jobs and money in their pockets, they will continue to do so. ■