The Economy

Inflation Weighs on Consumers’ Minds: Weekly Stat

Some consumers think their inflation-adjusted incomes will fall in the next year, according to the University of Michigan survey.

What do consumers think about the macroeconomy and their own economic prospects? The University of Michigan’s Consumer Sentiment Index, one of four data points we said CFOs should be tracking this year, shows widespread pessimism sinking in.

The index fell to 59.4 for March, it was revealed last week, down from January’s reading of 67.2. (See chart.) 

The last time consumer sentiment sank that low was August 2011, thanks to a U.S. sovereign debt downgrade and a short recession. The sentiment index dropped to the mid-50s during the 2008 financial crisis, and before that, June 1980’s mix of double-digit inflation and a 7.5% unemployment rate had soured the consumer outlook.

In contrast, CFOs might think the current U.S. economy doesn’t look so bad. But high inflation is back, and it’s rattling consumers. 

Respondents to the University of Michigan’s survey mentioned inflation no matter what question they were asked, wrote Michigan economist Richard Curtin in his monthly analysis of the consumer survey data.

“When asked to explain changes in their finances in their own words, more consumers mentioned reduced living standards due to rising inflation than any other time except during the two worst recessions in the past fifty years: from March 1979 to April 1981 and from May to October 2008,” Curtin wrote.

Nearly one-third (32%) of all consumers responding predicted their overall financial position would worsen in the year ahead, the highest recorded level since the surveys started in the mid-1940s.

Why? Michigan surveyed the same people on their expectations for the rate of inflation over the next 12 months. The expected year-ahead inflation rate as of March was 5.4% (see chart), the highest since November 1981 (when it hit 7.3%) and a half a percentage point increase from February. (The New York Federal Reserve Bank’s February inflation expectations survey showed similar results, with consumers expecting 6% price growth.)

If inflation stays that high in the next year, there’s a distinct possibility the inflation-adjusted incomes of some households will decline. And with a strong jobs market, these workers may force companies into a second round of pay raises to prevent them from departing to companies that will pay them more. Those increased costs will be passed on, once again, in the form of higher prices to customers. 

If inflation expectations go high enough, households may start pulling forward their purchasing despite higher prices, according to Ricardo Reis of the London School of Economics in a fall 2021 academic paper, “Losing the Inflation Anchor.” That will add to the supply-demand imbalance and motivate another cycle of price and wage increases.

It will be much less costly to the U.S. economy if increasing the Fed funds rate and other actions by the central bank head off such inflationary psychology, according to Curtin, before “it becomes ingrained in the economic behavior of consumers and firms.”

At the same time consumers feel threatened by rising prices and geopolitical uncertainty, they are losing faith in the federal government’s economic policies, according to Curtin. Half of all respondents to the Michigan sentiment survey unfavorably assessed current government economic policies, more than three times the 16% who rated them favorably.

Sentiment and projections aren’t everything, of course. There’s also behavior. This Thursday, data on consumer spending and personal income from the U.S. Bureau of Economic Analysis will be revealed, and before that on Tuesday, job openings and job quits get reported in the Job Openings and Labor Turnover Survey. That will help answer the question of whether consumers’ high levels of pessimism have affected their decisions about spending and their job situations.