How Could an Economy Be Better When People Think It’s Worse?

We have a mystery.

The economy is okay, but many people believe it is not.

Economic Misinformation

In a paper called, “Why do We Dislike Inflation?” a Harvard economist provided some answers. The big message was that by shrinking buying power, we expect inflation will reduce our standard of living. On the practical side, we believe it changes the quantity and quantity of what we buy, especially if our income is low. But then, affecting a vaster group, we perceive inequality. We see higher income households enjoying rising incomes more than others. Then, compounding our feelings, we blame corporations for benefiting disproportionately from unnecessarily rising prices.

What We Believe

Through one survey (December 2023) with “closed-ended” questions and a second one with longer open-ended replies (January 2024), participants conveyed their explanation of inflation. 1500 people took the first questionnaire while 504 were given the second one.

Predictably, they began with the basics. Researchers needed to know how people defined inflation. Summarizing the results, they found that almost half were “relatively” correct. At the same time, 44% provided inaccurate replies:

As for the impact of inflation, most were negative. Ranging from financial hardship to homelessness to creating the great Depression, the replies were dismal. They also thought, mistakenly, that their retirement savings and investments had gone down. Furthermore, they expected political instability and a diminished international reputation.  Meanwhile, the best that emerged from the upside was being forced to budget.

But your politics and your income affected your answers. Republicans and lower income households tended to have a bleak outlook.

However, some conclusions grew from misinformation. Close to 80% of respondents said, inaccurately, that prices were rising faster than wages. In addition, they cited a 5% inflation rate that was more than a point higher than the actual 3.4% 2023 number. At the same time, a reality check reveals vibrant employment growth, a healthy GDP, and a soaring stock market. At Vanguard, the average retirement account was up 19%.

For the survey, respondents also stated what they thought caused inflation:

Our Bottom Line: Causes of Inflation

Asking about inflation, most economists cite three causes. They say demand pull when you and I want so many goods and services that retailers raise prices. Others name a cost push cause of inflation when the factors of production–land, labor, and/or capital–become more expensive. Then finally, they say inflation could be the result of one commodity’s price, like oil, skyrocketing.

We should note though that if you are a monetarist, then you say that inflation is always a monetary phenomenon.  Referring to MV=PQ where M is the money supply and V is its velocity, you say that M is your focus. When it goes up excessively, then the price of PQ, the equivalent of the GDP, will become inflationary.

Concluding with the solution to our mystery, I suspect our response to inflation is the reason we perceive other economic statistics inaccurately.

My sources and more: H/T to WSJ for inspiring today’s post. But it was their link to this Brookings Paper that provided the details. I would also suggest looking at why, in the Misery Index, inflation should have more weight.