by The United States just experienced one of the largest collapses in consumer inflation in modern history. In June 2022, consumer prices had resurrected 9.1 percent compared to the previous year. By December 2023, the rate of increase had slowed to 3.4 percent. And yet, in poll after poll, voters continue to declare that inflation is at or near the top of their list of concerns.
Why don’t voters recognize the falling inflation rate? Because voters are humans, and humans don’t think rationally about inflation. To understand why, let’s look at a Snickers bar.
In the United States, more than 12 Snickers bars are sold every second. That makes Snickers bars a very important part of consumer purchases, so the price of a Snickers bar must be included in the inflation calculation. However, Snickers bars don’t eat up a big chunk of most families’ annual budget (at least they usually don’t).
Most of us will spend much more than our budget on something like a television. With $1,500 a consumer could buy a high-end 55-inch television, or almost four Snickers bars a day for a year. Because items in the consumer price basket are weighted roughly by the amount of money consumers spend on that item in a year, television prices are more important than Snickers bars in the calculation of the price basket. inflation.
However, we probably buy a Snickers bar much more frequently, perhaps even daily. Therefore, we are much more likely to remember the price of the Snickers bar and forget the price of the television we bought last year. Consumers tend to think only about prices high-frequency shopping: food for the family and fuel for the SUV
The different inflation rates for frequent and infrequent purchases is a large part of the reason why consumers mistakenly believe that inflation is higher than it really is. The prices of more expensive goods such as furniture and consumer electronics are actually falling – and have been falling for more than a year. Once the post-pandemic surge in demand for electronics, furniture and similar items faded, manufacturers were unable to maintain higher prices, lowering reported inflation numbers.
Unfortunately for the Biden administration, however, food prices They continue to increase, a fact evident at every supermarket checkout. Less than a tenth of the average household’s budget is spent at the supermarket, but the prices paid there dominate consumer perceptions of inflation. The result is that consumers perceive inflation as higher than it really is.
This is not an exclusively American phenomenon. In 2002, Italian consumers they were convinced Inflation was 18 percent year after year, when the reality was 2 percent. Exhaustive investigation revealed that an increase in the price of a cup of espresso generated much of this erroneous impression.
The fact that we are all predisposed to remember more often the price of purchased things is aggravated by two other phenomena. Humans are genetically programmed to emphasize bad news over good news when making decisions. Loss aversion is a primitive survival mechanism: we run from the tiger faster than we run to food.
In the sense of inflation, this means that people tend to put more emphasis on price increases (which represent a loss of purchasing power) than on price falls. In extreme situations, this emphasis can span generations. For example, Germans are horrified by rising prices today because the losses generated by hyperinflation in the 1920s and 1940s have become part of society’s collective memory. This has produced strong popular support for central bank independence and a reluctance to run large fiscal deficits.
Additionally, large price increases are burned into consumers’ memories, even if the item is a relatively unimportant part of their budget. A chocolate bar whose price rises 20 percent, from $1 to $1.20, will provoke a feeling of outrage, even if your total spending on chocolate is, hopefully, quite limited.
Consumers also tend to focus on price levels. A slowdown in the inflation rate does not mean that prices are back to where they were; It simply means that prices are rising at a slower rate than before. Consumers who have experienced a long period of low inflation, when many prices were static, want to return to the price level they remember.
The last time consumer price inflation was above 4 percent for more than a few months was in the early 1990s. If something cost $1 for a decade, consumers resent the fact that the same product costs $1.20 today, even if the price of that product is no longer increasing. Mentally, consumers feel that the product should cost $1 and are nostalgic for the previous price.
This mentality is one of the reasons for what is sometimes called “counterinflation”: companies will keep the price of their products constant, but reduce the size of the product. Consumers get less for their money, but the unchanged price prevents negative nostalgia. (It should be noted that consumer price inflation is not fooled and a reduction in the size of a product is recorded as a price increase in inflation data.)
All of this may help explain why the same consumers who believe inflation is higher than it really is are not aggressively cutting their own inflation. spent. Regardless of how consumers feel about the damage of inflation, they will continue to spend the money they have. The mantra “never underestimate the hedonism of the American consumer” still holds true.
It can certainly be questioned whether politicians or central bankers can take much of the credit for the decline in inflation. The transitory durable goods price inflation of 2021 was always likely to reverse as consumer demand for furniture and electronics adjusted after the pandemic. The profit-driven inflation of recent months rarely lasts long, with consumers rebelling against profit margin expansions and companies rushing to shore up customer loyalty with price stability and targeted discounts.
However, the risk is that the current situation will lead to the authorities being blamed for something that no longer exists. The political risks of misperception of inflation have been known for a long time. President Richard Nixon was well aware that raising shopping prices more frequently could hurt his re-election effort in 1972. At that time, prices were not set by the market. In 1971, Nixon froze all wages and prices (except agricultural products) for 90 days by executive order, and then established government control of wages and prices.
Within this policy, the Nixon administration became obsessed with food prices. Hamburger meat, in particular, was a recurring theme. As a Nixon aide, Charles Colson, described it, hamburger meat “seems to be the only very visible and significant item to the housewife.” Gender stereotypes seem archaic half a century later, but the principle remains valid. The overall pricing strategy was a political success (Nixon’s economic approval ratings rose), but it ultimately led to shortages and contributed to the rapid inflation that occurred after the election.
As the United States prepares for a deeply polarized election, perception matters. Throughout 2023 center presented inflation as voters’ biggest economic concern. Similarly, President Biden receives lower support for his management of the economy than of other political areas. If high-frequency purchases continue to rise in price, consumers are likely to discredit policymakers’ claims of economic improvement. On the contrary, if disinflation takes hold in food and fuel, there may be more satisfaction with economic policy.
The aisles of Walmart may become one of the most important battlegrounds for the 2024 elections.
Paul Donovan is chief economist at UBS Global Wealth Management and author of “The Truth About Inflation.”
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