You don't understand economics

University of Michigan Consumer sentiment The survey, a national record of U.S. consumers' sentiments about the health of the economy, has finally caught up to the reality of inflation and low unemployment, recovering from the COVID-19 pandemic. There's just one problem: it should have happened months ago.

Inflation, as measured by the Consumer Price Index, has slowed steadily since late 2022 and is currently on track 3.1% – It will be the lowest after March 2021. UnemploymentAlthough Predictions Among many leading economists, 2021. From 2023 is relatively low. Consumer spending The country-wide economy staved off recession and remained strong in the face of rising interest rates. Gross domestic product, a measure of all the goods and services an economy produces in a given year, has risen 3.1% During 2023. Based on all indicators of real economic performance, consumer sentiment should have already responded to these positive trends. Why is it back now?

People don't see the economy right. For many For consumers, macroeconomics is an abstract framework and they base it on personal perceptions rather than actual developments. People reach for information that is highly visible to them, which often has nothing to do with reliable economic indicators.

For example, rather than economic measures such as unemployment and inflation, the evidence strongly suggests stock market performance. is driving Consumer sentiment. As it happens, the recent recovery in sentiment coincides with a market rally, as the S&P 500 index recently hit a new high. record high. A 1999 Federal Reserve analysis illustrates that individuals view a rising stock market as a leading indicator of a positive economy. In other words, consumers believe that rising stock prices are a sign that good times are ahead, and vice versa.

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However, this view is wrong.

In 1966 Article For Newsweek magazine, noted economist Paul Samuelson quipped that the stock market has predicted nine of the past five recessions. The 13th Bear markets The postwar era led to only seven recessions within a 12-month period.

Consumer sentiment fails to reflect the real economy in other cases as well. On the infamous day black monday, an unexplained 22.6% drop in the Dow Jones triggered a massive drop in consumer sentiment despite no change in economic factors such as unemployment or inflation. If sentiment had been more responsive to the real macro economy than equity values, the collapse would not have occurred.

One explanation for the market's inability to represent the economy is that stock prices are driven more by human emotion than by changes in the real economy. Hope that a struggling company's fortunes will improve, or irrational fear about the fate of an industry, often causes stocks to rise and fall involuntarily. In his book „Irrational excitement,” economics Nobel laureate Robert Schille cites investor overconfidence and “magical thinking” as the main reasons equity values ​​diverge from what might be considered rational. Investors tend to think they know more than they actually do, while others believe they may be mirroring their own actions. Also, investors often make uncertain judgments that future patterns will resemble past ones—a phenomenon referred to as the psychological phenomenon. Representation heuristic.

But why do so many people tend to mistake the stock market for the real economy? For one, not everyone has the time or opportunity to attend an economics class where they can learn the difference between the two. Even in basic macroeconomics courses, students are taught that inflation, unemployment, and GDP are all economic indicators. Understanding the fundamentals of economic development requires some effort and may be difficult to achieve outside of an academic setting.

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However, the failure to understand economics goes beyond education. Individuals have a complex tendency to absorb visual information. For most people, the stock market is more tangible than real economic indicators. Every iPhone comes with Shares The app is already installed, making the movements of the S&P 500 and other indices a click away. Televisions in restaurants, hotel lobbies and our own intramural sports building regularly turn to CNBC, where passionate commentators discuss the latest moves in the market. Knowing about inflation and unemployment, on the other hand, requires that the data be intentionally informed.

Mass media only exacerbates the disconnect between people and understanding economics. News about the health of the economy is often influenced by stock market movements, even if that coverage isn't perfect. After all, stocks are an easy metric to base an economic report on. It may be natural for news organizations to cover an improving economy when investors are bullish on the stocks of companies that make up the economy. If investors think companies are doing well, the real economy should improve as well. Of course, the code from the Federal Reserve Bank of San Francisco Daily News SenseIt tracks the tone of news coverage rather than consumer sentiment, which rose sharply when the current rally began.

Consumer awareness is key. It reflects how those affected by the economy feel about their financial security, employment opportunities, and ability to meet daily living expenses. Elections can also be decided. In 1980, 1992, 2000, 2008 and 2020, the White House party changed hands during periods of declining consumer sentiment. Closely linked to consumer sentiment, S&P 500 returns are right on track predicted In every presidential election since 1984.

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But the real health of the economy has little to do with consumer sentiment. The economy is real, and its well-being depends on how many people are employed, how high prices are, and how many goods and services are produced. But Americans don't understand this. By tying rising equity values ​​to a high-performing economy, consumers have undermined the value of a significant statistic with the power to influence presidential elections. To provide an accurate reflection of the economy, consumers must make more informed and accurate decisions about the information they absorb. You affect the economy. It is important that you understand that.

Lucas Feller is an opinion columnist from Glencoe, Illinois. He writes on politics, economics and constitutional law. He can be approached [email protected].

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