Why is Consumer Sentiment Low, When the Indicators are Good?

Why do Americans remain guarded about the economy's prospects when all signs point to a robust financial landscape? Together with Dr. David Axelrod from the Feliciano School of Business, we unravel this enigma. The economy is booming on paper—GDP is up, and joblessness is down—yet there's a palpable sense of unease about what lies ahead. We dissect the impact of inflation and higher interest rates, the weight of credit card debt, and why the inflationary burden isn't shared equally.  Beyond the numbers, today's economic sentiment is colored by the long shadows of climate change and global unrest, factors that balance sheets have yet to fully account for. 

Strap in for a thought-provoking ride as we probe the challenges of future economic planning amid present-day success stories. In our conversation with Dr. Axelrod, we confront the paradox of a future that's growing murkier even as our present metrics shine bright. Interest rates creep up, the divide between the haves and have-nots widens, and the cost of borrowing from tomorrow's promise increases—these are but a few of the complexities we navigate. Join us for a deep analysis that goes beyond the headlines, offering a sobering look at the fragility of consumer confidence and the seismic shifts that could redefine our economic landscape.

Dr. Axelrod received his Ph.D. in Economics from Rutgers University in 1990, with the dissertation Three Essays on Latency in Economics and Decision Making. He has taught at Montclair State University as an adjunct professor since 2013. Previously, he worked in finance for twenty years as an economist, consultant and actuarial analyst, including positions with Falcon Management, Volvo Finance, and Crum & Forster. He has also produced research in health economics, and the nature of choice and well-being. Dr. Axelrod provides holonomic consultation and workshops. He plays electric bass and has released over a dozen albums of original music. 

Transcript

Speaker 1: 0:00

Why is consumer sentiment low when the indicators are good? Dr David Axelrod at the Feliciano School of Business. Four years ago, the COVID pandemic hit the US. Our economy experienced a partial shutdown that led to a very rapid rise in unemployment and drop in production and drop in production. Various policies to stimulate the economy, including increased federal spending and easing monetary policy, kept us from falling into a depression and enabling a fairly quick recovery. However, the amount of stimulus, along with disrupted supply chains, led to an inflation spike in 2022. The Federal Reserve responded by raising interest rates in a mostly successful attempt to reduce inflation. Today we have a growing economy, low unemployment and moderating inflation and moderating inflation. Yet consumer sentiment is anomalously low and many Americans still feel it is on the wrong track. Let's explore how this could be.

Speaker 1: 1:18

One of the challenges of setting macroeconomic policy is which indicators to use. The three most prominent are GDP, inflation and unemployment rate. Gdp indicates how much an economy produces, inflation indicates how quickly prices are changing and unemployment rate indicates the prevalence of people who want paid work but do not have any Of these. Households most directly experience unemployment and inflation. Another indicator, consumer sentiment, attempts to capture how optimistic consumers feel, as this says something about whether households are likely to buy more or buy less in the near future. For decades, movements in the unemployment rate and inflation could be used to explain movements in consumer sentiment. However, recently there has been a bit of a decoupling. In particular, unemployment rates are historically low, gdp continues to grow and while inflation is above the target set by the Federal Reserve, the US's central bank, it has declined sharply over the last year and a half. Yet consumer sentiment has not recovered much and is similar to that of the Great Recession in the late aughts. So why is it so low? But those other indicators are good. It relates to another important factor the price of borrowing. In a recent NBER working paper titled, the Cost of Money is Part of the Cost of Living. This anomaly is associated with another part of the consumer's decision-making the interest rate at which they can borrow.

Speaker 1: 3:32

One of the ways the Fed attempts to quench inflation is by raising interest rates. The reasoning is that when interest rates go up, households tend to consume less and businesses tend to invest less. This implies the demand for goods contracts, and while that can lead to shrinking the economy and higher unemployment, it often leads to diminished inflation, as long as consumers reduce their spending quickly enough, they can diminish the impact of the increased interest rates on the amount they owe, for example, on credit cards. The amount they owe, for example, on credit cards. However, households and businesses had adapted to a world of very low interest rates.

Speaker 1: 4:25

From early 2009 until early 2022, the US economy experienced historically low borrowing costs. While this had made it easier for people to buy homes due to low mortgage rates, it also made it easier for people to carry large credit card debt as well. When inflation started to accelerate and yet wage growth lagged, people borrowed more to maintain their lifestyle, while manageable at low rates. When interest rates jumped quickly in 2022 to deal with inflation, there was little room to adapt. Households spent more to service their debts. To adapt, households spent more to service their debts. This became a vicious cycle between the amount of debt increased and the amount of interest owed. One implication is that the estimate of the cost of the standard market basket of goods used to estimate the CPI fails to capture the increased expense due to that borrowing. This leads to another contrast the experience in the change of the cost of living by wealth and income levels, based on another study by the Bureau of Labor Statistics, over the last 20 years, the CPI for the lowest income quartile has increased faster than for the highest income, even before increased borrowing costs are included, the only exception being the first year of the pandemic.

Speaker 1: 6:18

For those that do not need to borrow, increasing interest rates has a positive impact on their well-being from higher return on their savings. For the poorest, the extra governmental aid received after the pandemic helped lump some of the harshest short-term impacts from the increased cost of borrowing. This can be seen in measures of income inequality in the first couple of years of the pandemic, where pre-tax income had become less equitable, but post-tax income became more equitable, but post-tax income became more equitable. As those benefits stopped, the trend toward increasing inequality has resumed.

Speaker 1: 7:11

Based on the University of Michigan Consumer Sentiment Index, we can see that historically, before the pandemic, the index showed differences correlated with income class. However, from mid-2021 through the end of 2022, the sentiment index ceased to vary by income class. It then starts to spread out again through 2023 and 2024. One way to understand this is that, as prices grew faster than wages, households increased their borrowing to make up the shortfall. This would be done by heating up credit cards and steeper mortgage payments, and we do see a significant increase in the amount of credit card debt. However, the average interest rate on the debt saw a large jump, nearly doubling. The combination of more debt and much higher interest rates means households are spending much more just to finance the life to which they are accustomed. This leads to another aspect to consider that consumer sentiment is not affected only by what is happening now, but also expectations for the future.

Speaker 1: 8:39

Even after accounting for unemployment rate, inflation and changes in interest rate, there is a statistically significant negative impact associated with time. It is as if the various future issues like climate change, sustainability, population stressors and overall conflict between countries keep getting closer and increasingly difficult to ignore. This impacts our sense of well-being, even as what is occurring in the moment seems fine. The crises that were once so far in the future we could ignore them were no longer beyond the horizon. In finance and economics, we use the concept of present value the value today of net income in the future to aggregate the perceived value of the future out to the time horizon of the future out to the time horizon. The time horizon is the point in the future after which we ignore its impact on present value, often because it becomes too uncertain what it will look like. Thus, back in 1980, the challenges to be faced in 2030 tended to be ignored by most people as too far in the future. However, in 2024, they are getting close enough to have crossed from beyond to within those horizons.

Speaker 1: 10:15

The implication is that all the consequences of past decisions and choices have become close enough to impact the totality of our sense of well-being, not unlike currently being able to drive the speed limit on a highway and then seeing, a mile down the road, a traffic jam.

Speaker 1: 10:36

You are not in it yet, but you know you will be not in it yet, but you know you will be. So our capacity to savor the present by delaying costs into the future is reaching its limits. One way this shows up would be in decreased sentiment. Another is having to pay more to borrow against a dwindling supply of feasible futures. A dwindling supply of feasible futures. We see, then, that the overlay of increasing interest rates, greater income inequality and darkening clouds on the horizon over otherwise good indicators for economic growth, unemployment and moderating inflation helps us to understand why consumer sentiment is depressed, even if the economy as a whole is not. It is also suggesting a shift in awareness, if not consciousness from the momentary now toward an impending future. Hopefully, recognizing these anomalies can lead us to create, and not just imagine, better economic experiences.