Don’t Ask People How The Economy Is Doing

Why would they know?

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Everyone seems to think the US economy sucks. By “everyone,” I mean real people, not economists, especially not economists on Twitter.

Yet, lots of economic indicators are quite good. GDP growth is good. Inflation is cooling. Unemployment is low. Why do people think things are bad? People have thrown around lots of theories. Real wages haven’t grown much over 4 years and are below trend. People hate inflation, so they keep thinking about that, even if it has cooled.

I’m going to take another approach to this puzzle. People have no reason to know about “the economy.” When asked on a survey, people are just wrong about macroeconomic facts. For example, 73% of people thought inflation rose in the past year in the US. (HT: Justin Wolfers and Andrew Lay)

This should be no surprise. Why would people know? There is no reward for knowing about aggregate inflation or unemployment outside of very select professions. Instead, as Hayek explained, most knowledge is dispersed and context-dependent. Your average person only has expertise about their immediate circumstances, not aggregate economic performance. They need to know about their markets, not fictitious aggregate markets.

Given people have no clue about the economy, why should I (and you, dear reader) care what they think about the economy?

Before I get hung out to dry, there's an important distinction we need to make between "how are you feeling economically (financially)" and "how is the economy doing." The former asks about personal welfare and sentiment. People can speak directly from their lived experience on that. But commenting on overall economic conditions requires data and analysis that everyday folks simply don't have. Their confidence or pessimism reveals little. Asking them about the economy gives us approximately zero information about the economy.

My coauthor Josh made this point about prices in a previous newsletter. To use his example, the butcher may blame suppliers and shortages for why they need to raise prices. But prices can rise from demand shifts; their perspective gives little economic insight. Nor should it. Either way, whether it is a supply decrease or a demand increase, the optimal thing is to raise prices. We need economic theory to sort out causation.

Similarly, people have the same problem when they think about labor markets. Customers may see help wanted signs in a restaurant and assume “people don’t want to work.” However, the real story could be that workers have better options now, like Josh’s example of the butcher facing increased demand. The customer lacks insight into the full labor market dynamics. Why should they?

It's similar when directly asking people about “the economy.” Your average person isn’t following GDP growth rates, investment patterns, wage trends and so on. They know if they got a raise at work or if their neighbor lost a job. They see some prices rising, especially gasoline, but have a hard time distinguishing price levels from changes in price levels (inflation).

The same holds for news stories. Just this week, we have a BBC article on layoffs and a “vibecession.” After all, Etsy laid off 11% of its staff! Spotify cut 5%! Now that is terrible for the workers involved, but we are talking about a few hundred jobs in total. For context, in the US, there were 5.6 million job separations. In October! There is no possible way you could cobble together enough news stories to learn about the aggregate picture from the news stories.

That’s why we have data…

Vibecessions All Around

Speaking of “vibecessions” (a term from Kyla Scanlon), what is it? Kyla gives a fuller explanation, and many others have followed up, but the basic idea is that economic downturns can become self-sustaining due to sentiment. As expectations worsen, consumer and business decisions at the margins collectively propagate a downturn even if underlying conditions don’t justify it. So recessions sometimes stem more from “vibes” than statistics—we talk ourselves into decline.

Kyla makes a fair point regarding sentiment becoming self-fulfilling at times. When expectations spiral negatively, it likely impacts decisions that collectively sustain a downturn. So the “vibecession” rings true – we can talk ourselves into trouble on occasion. That’s an old idea that is important to think about. Economists have long theorized downturns often start due to pessimism that propagates. Consumer worries about losing jobs, for example, become company worries about falling demand. Kyla gave this concept an innovative name and explored subtle complexities around vibe shifts.

If people can talk themselves into a recession, then surely we should take seriously their sentiments, their vibes. It could be a leading indicator of a recession.

Plausible. I’m definitely open to the importance of coordination and people’s beliefs ultimately driving recessions. Half of my dissertation was on coordination failures!

But I’m skeptical in practice.

To the extent vibes genuinely move the economy, that impact must appear in data and statistics. I’m not saying anyone is suggesting otherwise. If it’s purely about business owner vibes, but we don’t see any change in their hiring decisions, what have we learned? What can we better predict? What policies should we do differently? It’s on par with a zero-price survey question that is contradicted by people’s actual behavior. If negative expectations are generating a downturn, indicators of actual consumer and business activity should reflect that eventually.

Perhaps consumer sentiment could even be operationalized into a novel leading indicator that predicts economic activity. I think that is a usual argument for thinking in terms of vibes. It gives us an idea of what is to come. By definition, these beliefs come before people make decisions. But until sentiment shows up quantitatively, I’m not sure what to do with that. Maybe that’s my shortcoming. How many false positives are we going to have? How many failed predictions are we going to make? As the old joke goes, economists correctly predicted 12 of the last five recessions.

Maybe someday, but I have not seen evidence it substitutes for traditional economic analysis. Vibes matter, so asking people how things are going matters, but we have no framework to incorporate the emotions and observations into formal analysis. This isn’t just about GDP or unemployment. The same holds for consumer surveys of inflation expectations. I would never use those to predict inflation.

Does anyone specialize in understanding the economy?

If we want to understand the economy, there is no way around it. We need economic theory. We need price theory. And we need to look at the data.

If that’s too cold-hearted for you, as Matt Darling puts it, if we want to understand employment, we need information from real life, like a monthly rotating panel of 60,000 people. (If you’re less of a nerd, that’s what makes up the Current Population Survey, or CPS, which is where we get things like the unemployment rate). What are broad employment and output metrics showing about production trends? What does money supply growth tell us about aggregate demand conditions? Only by analyzing the proper economic data can we hope to learn “how the economy is doing.”

So next time you see a politician or reporter asking a random person for economic analysis, remember that personal feelings provide zero insight into the economy's performance. Sorry. We don’t survey people to understand gas prices. We analyze supply and demand, not costs and shortages (which are what people observe). Let's apply that lesson to the macroeconomy, too. The data holds the answers, not human interest. Theory helps us sort through the data.

This is self-serving, but ask an economist! If you need a good one, I know a guy named Josh.