Why consumers think inflation is still really high when it’s not

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The punditry sections of many publications report what appear to be a set of astonishing results from a recent Harris Poll. Half or more Americans believe the U.S. economy is in recession (it is, in fact, growing), the S&P 500 is down (it is up some 25% in the last year) and that unemployment is almost at a 50-year high (it is at a 50-year low). Similarly, perceptions about runaway inflation persist even though inflation has declined dramatically in the last two years. To paraphrase Winston Churchill, this disconnect between perception and reality is a puzzle wrapped in a mystery shrouded in an enigma.

There are, I think, three reasons for consumer perceptions, particularly about inflation, that are at odds with reality.

First, consumers don’t think about “inflation” the same way economists do. To an economist, inflation is the rate of change in prices, or how much prices have increased for a basket of goods from one period to the next. If prices are going up quickly (as they were in June of 2022), inflation is deemed to be high, but if they are going up relatively slowly (as they are now), inflation is deemed to be relatively low. But in both cases, prices are going up. And to consumers, this is the relevant metric. When most consumers think about inflation, they think about absolute prices (“can you believe how much I paid for a tomato!”), not relative prices. So a declining trend in the inflation rate is meaningless if absolute prices do not decline. In other words, when consumers respond to a question about inflation, they are responding to their perceptions of the costs of their purchases. Consumers and economists are literally speaking different languages.

Second, there is the ubiquitous price of gas as a measure of the state of the economy. Economists who focus on “core inflation” do not include the price of gas in that metric because food and energy are deemed too “volatile.” However, for consumers, gas prices are extraordinarily salient. Unlike when buying groceries which involves a shopping basket of multiple products, when buying gas, consumers buy just the one product. And therefore, it is quite easy to assess whether the price has gone up, down or stayed the same compared with the prior purchase. Simply driving by a gas station every day, one can barely avoid noticing the price per gallon. To the extent that gas prices have risen and will continue to rise as the summer driving season approaches, consumer perceptions of inflation (or costs) will only become more negative.

And, the price of gasoline, particularly diesel, has an impact on the prices of other goods and services that rely on transportation, and therefore likely impacts core inflation. Most products need to get from Point A to Point B, and if the input cost of transportation rises, then product prices ought to rise. This is true of services as well — your hairdresser has to drive to work, and when gas prices rise, her input costs have risen, leading to pressure on the hairdresser to raise prices for a haircut.

Third, much like it is easier to change prices than to change price image, perceptions of the health of the economy tend to lag reality for good reasons. Attitude change is slow because attitudes are deeply embedded in a cognitive network of associations. So the long-held belief, reinforced by politicians and the media, that Republicans are better stewards of the economy than Democrats leads to the belief that things couldn’t possibly be better under a Biden administration when compared to the Trump administration. This belief, which is contrary to actual analyses, is one reason (among many) that yields the puzzling results revealed by the Harris Poll.

Such beliefs have real consequences. As has been widely reported, Target, Walmart, Walgreens and other retailers have recently announced price cuts in response to managers’ beliefs that consumers believe the economy is in the doldrums because of high inflation. Such price cuts could lead to price wars that, while beneficial to consumers, at least in the short run, could be debilitating to firms in the long run, as I and my colleagues have argued. Price reductions, when not accompanied by corresponding reductions in input costs, damage profits. Perhaps more important, price competition teaches consumers to shop on price rather than on quality, potentially reducing the quality of products and services available to consumers as firms engage in a race to the bottom.

So, what is to be done about perceptions that are so entirely at odds with reality? Can one persuade consumers that inflation is declining, that the stock market continues to flirt with record highs virtually every week, that unemployment is at an all-time low and that rising wages now more than compensate for rising prices? Probably not, particularly since these perceptions are deeply held convictions driven in part by political ideology. People are happy with their own financial situation but many still deem the economy to be in dire straits in part because the media echo chambers they draw information from tell them so. It is difficult to tune into a Sunday talk show and not hear a politician bemoaning the state of the economy and high inflation, with nary an anchor pushing back with actual data.

The bottom line is that until consumers’ lived experiences lead to a sense that the general economic standard of living has stabilized or improved regardless of the objective macroeconomic data, they will be persuaded by the constant barrage of commentary telling them how bad things are. And, by definition, such negative information is more salient, attention grabbing and persuasive than accurate, positive information. Particularly for low-information consumers. And to the extent that these perceptions translate into voting behavior, perceptions that are at odds with reality can have electoral consequences. According to a quote attributed to Thomas Jefferson, “A properly functioning democracy depends on an informed electorate.” It is therefore obviously critical that the electorate be informed by a common set of facts lest one’s political lens distort reality to the point that democracy itself is threatened. The burden then falls on citizens, the media, government and other institutions to ensure consumers and voters are accurately informed, a task that is increasingly difficult in a world of misinformation and disinformation whether it be about vaccine efficacy or the macro economy.

Akshay R. Rao holds the General Mills Chair in Marketing at the University of Minnesota’s Carlson School of Management. His latest book, “Patient,” is available at ProfAkshayRao.com.