Consumers See Bad News

The Reuters-Michigan survey of consumer sentiment registered a decline from 77.5 in February to a preliminary reading of 68.2 in March. That’s the biggest monthly decline since the financial crisis in October 2008, and wipes out the nice gains of the last four months to put us back where we were in October 2010.

Consumer sentiment and economic recessions, 1978:M1-2011:M3. Data source: FRED and contemporary news accounts.

I noted a few weeks ago that the lost consumer purchasing power from the oil price increases seen so far could subtract 1/2 percent from GDP. Consumer sentiment is not the most important economic indicator, but it does seem to be one factor in why spending sometimes responds by more than the simple calculation behind that 1/2 percent figure would suggest. The connection between gasoline prices and consumer sentiment is pretty well established. A recent study by Paul Edelstein and Lutz Kilian (published version here, working paper here) estimated the following relationship over 1970-2006 of how consumer sentiment declines after an increase in energy prices.

Impulse-response function and 95% confidence intervals from bivariate vector autoregression for response of Reuters/Michigan index of consumer sentiment to an energy price increase that reduces disposable income by 1%. Reproduces Figure 11a in Edelstein and Kilian (2007).

We had been getting some good economic news on other fronts lately, which I had been hoping would be enough to offset the hit to consumers’ budgets from energy prices. The March numbers so far are just preliminary, and consumer sentiment is a somewhat noisy indicator. But whatever you make of the latest report, it is not good news.

Another question asked in the survey pertains to expectations of inflation. Consumer expectations of inflation for the next year jumped from 3.4% to 4.6%. Again gasoline prices seem to figure more prominently in consumers’ expectations than we might have expected, and again we can do a simple mechanical calculation of the direct effect. Gasoline prices have a weight of about 5% in the CPI, so if all other prices were held fixed, the 20% increase in gasoline prices we’ve seen over the last 3 months would add about one percentage point to the CPI.

U.S. national average retail gasoline price. Source:

The Fed tends to focus on core inflation rather than the headline inflation, in the belief that the energy price hikes won’t continue and are not themselves reflecting U.S. monetary policy. I’ll leave both those issues for future discussion, and confine myself here to the observation that the nature of the shock we’ve seen is stagflationary, simultaneously reducing expected real GDP growth and increasing expected headline inflation. The magnitudes may be modest– perhaps a single percentage point for each. And although the Fed had been wanting to see a slightly higher inflation rate, I do not believe the form in which the news is coming is altogether welcome.

Retail gasoline price by county. Source:

Originally published at Econbrowser and reproduced here with permission.