Why We're Gloomier Than The Economy
Consumer Anxiety Outstrips the Data

By Neil Irwin
Washington Post Staff Writer
Wednesday, June 18, 2008

Ask Americans how the economy is doing, and their answer is stark: It is not just bad, it is run-for-the-hills terrible. Consumer confidence is at its lowest level in almost 30 years. Only 12 percent of Americans think the economy is in good shape. On the Internet, comparisons to the Great Depression are widespread.

But the reality is different. According to most broad measures of how the economy is doing, it's not all that grim.

Soft? You betcha. In recession? Quite possibly. And a crisis in the financial markets has rattled nerves for months now. But so far, the economy is holding up better than it did during the last two recessions in 1990 and 2001. Employers haven't shed as many jobs, the unemployment rate is still relatively low, and gross domestic product has kept rising. Things are nowhere near as bad as they were in the Great Depression, or even during the severe recession of 1982-83. The last time consumers were this miserable, in May 1980, the jobless rate was 7.5 percent and inflation was 14.4 percent. Now those numbers are 5.5 percent and 4.2 percent respectively.

This paradox has created a unique challenge for those guiding the economy, who worry that Americans' pessimistic views will become a self-fulfilling prophecy. Two-thirds of the economy is consumer spending. So if people's negative outlook leads them to cut their spending, a steeper downturn could happen.

This has left economists trying to figure out why Americans' perceptions are so much more negative than the data analysts use to measure how things are going.

"We're saying that we feel a lot worse than we did at the depths of the last recession, when we had had 2 or 3 million job losses, that we feel worse than we did after

9/11," said William Cheney, chief economist of John Hancock Financial Services. "At some level, that just doesn't make a whole lot of sense."

But through the prism of daily experience, it may.

The run-up in gasoline and food prices, for example, appears to affect people's perception of how they're doing more than a similar price rise in other goods.

Eric J. Johnson, who studies behavioral economics at Columbia Business School, offers this example: Someone who has to pay an extra $25 to fill up his car is reminded of that cost once a week -- or more often if you count the times he is driving down the road and sees the $4 per gallon price in giant numbers on a sign. Technically, he is no worse off than if his rent had increased by $100 a month. But it feels a lot worse.

"Things that you buy more frequently and that have large percentage increases will weigh more in people's perception of inflation," Johnson said.

Not only that, but increases in the price of gasoline and food affect almost everyone.

"If the unemployment rate goes from 5 to 7 percent, that affects 2 percent of the population," said Michael Feroli, an economist at J.P. Morgan Chase. "If gas prices go up, almost 100 percent of the population feels terrible."

Another possibility: Americans have been unnerved by the financial crisis that was a major cause of this broader economic slowdown. The credit crisis has spilled from one part of the financial markets to another. At times, the wheels of global capitalism have appeared to be at risk of coming off.

Although trouble in the financial sector is not the same as a generalized disorder of the economy, ordinary Americans may not make that distinction.

Another factor is that homes are losing value -- and this reduces the wealth of more people than a plummeting stock market like that of 2001. Currently, 68 percent of Americans own their home. In 2001, only 21 percent owned stocks directly.

Moreover, housing values literally hit closer to home. A person's stock holdings can seem like a paper abstraction. But the value of the four walls that a person calls home is more tangible and can seem more secure even though it may be every bit as volatile.

Wellesley College economist Karl E. Case and two co-authors researched how changes in the value of homes affect what people spend and got a curious result: When home prices are rising, people spend more money. When they are dropping, they don't spend less money. With stocks and other assets, by contrast, spending both rises and falls with prices.

"People spend more when house prices go up and worry more when prices go down, but don't actually spend much less," Case said. "That could explain why consumer spending numbers have been much more robust than you would expect if you look at consumer sentiment."

Some analysts attribute Americans' negative views on the economy to media coverage, which tends to play bad news more prominently than good news. There is ample research proving that, say, a drop in the stock market or rise in the unemployment rate gets more extensive news coverage than a move in the reverse direction. (In other news, newspapers tend to cover plane crashes more extensively than a safe landings).

But that has been true during past downturns. There is no obvious reason that it would be more pronounced now than in 2001 or 1990, when consumer confidence did not drop as much as it has recently.

The biggest reason for people's gloom might be because of what they're used to. In the 1980s and '90s, memories of the double-digit unemployment and double-digit inflation from the 1970s were still fresh.

"People expected very little out of the economy," said Richard Curtin, who has administered the University of Michigan's survey of consumer sentiment for 35 years. "Compared to what their frame of reference was, the performance of the economy was absolutely tremendous."

But now, coming off two decades of prosperity and low inflation, Americans have come to treat low unemployment and inflation as givens. We have gotten so used to things being good, in other words, that even when conditions become somewhat bad, it feels terrible.

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