Americans are downbeat about the economy, even as inflation rates rapidly decline back toward more normal levels, the unemployment rate has held below 4% for the longest stretch since the late 1960s and economists race to raise their growth forecasts. And yet, sentiment has been at levels typically seen in recessions since the start of the pandemic.1
Lots of reasons have been given for the gloominess, including political partisanship, the media’s focus on negative news stories and bad “vibes” in general. There’s another, less talked about but more likely explanation for the disconnect: Covid-19 itself. The timing is clear, sentiment plunged at the start of the pandemic but failed to rebound when the economy re-opened and snapped back. In terms of sentiment, the pandemic caused a sudden increase in pessimism that hasn’t gone away.
In the debate over whether the US will fall into a recession, the conundrum around low levels of consumer sentiment is a big problem. Historically, sentiment was often helpful in predicting an economic contraction, but it seems to be out of commission as a useful signal at the moment.
Economists David Blanchflower and Alex Bryson showed that consumer sentiment predicted all US recessions since the 1980s up to 18 months beforehand. Based on their analysis, the US would have been in a recession in the fall of 2021, but that didn’t happen. Sure, it is possible that the predictive nature of sentiment will prove correct but with a longer-than-usual lag – we just won’t know until it happens (or doesn’t).