We Can’t Let Bad Vibes Lead Us to a Recession

The economy is the story of what people do — how we spend money and time, the quantitative and the qualitative aspects of our existence. When that story becomes too noisy to interpret, people begin to expect the worst. Conflicting narratives about the state of the economy are colored by conflicting interpretations of those narratives, and discerning what is actually happening in the economy becomes near impossible. What people expect can soon end up happening, and right now, with worsening data, many people’s expectations have come together to expect a recession. And those expectations could very well lead to one.

Gross domestic product shrank in the second quarter of 2022, continuing a downturn from the quarter before. These G.D.P. figures were the icing on the cake of bad news — a 9.1 percent surge in the Consumer Price Index, skyrocketing home prices and a softening labor market, as evidenced by an increase in jobless claims.

Economic indicators are a Jackson Pollock painting of data points and trends. If you think hard enough about all of them, they begin to make a bit of sense, but there’s a lot to interpret. Economists have baseline theories about what the economy should do, but a pandemic, a war and supply chain woes have widened the gap between the “reality” of economic data and people’s experiences of that reality. If we’re not careful, flawed assumptions — what John Maynard Keynes called “animal spirits” or what the economist Fischer Black called “noise” — will fill that gap and fulfill our worst expectations.

Around 70 percent of G.D.P. is consumer spending, which is largely driven by consumer sentiment. How you, I and everyone else feel about the state of the economy determines what and how much we buy. Recent consumer confidence metrics have been weak, with the Conference Board’s Consumer Confidence Index falling to the lowest level since February 2021. According to the Bureau of Labor Statistics’ figures from last week, inflation-adjusted wages have fallen 3.1 percent in the past year‌, and as prices increase, ‌purchasing power continues to fall. The housing market is nearly impossible to break into, as home prices have soared 40‌ percent over the past two years. Broadly speaking, consumers don’t feel great right now about their ability to afford anything.

Many blame inflation on corporate price gouging, and there is definitely a kernel of truth to that. However, many corporations’ earnings expectations are plummeting as they also struggle with higher production costs. Several retailers are entering an environment where their inflation becomes deflationary as the excess inventory they ordered to battle supply chain uncertainty is now marked down in an attempt to sell it.

A budget constraint to both consumers and corporations is a lack of necessities like natural gas and oil. When energy prices go up, everything has to go up in price, and that can result in a double cost impact for consumers.

The Federal Reserve, the ultimate vibe setter in both good times and bad, is going full “Fast and Furious” mode to try to battle inflation. The Fed’s main tool now is to worsen the overall vibes — managing demand by raising rates and making it more expensive for people to buy things.

People’s perceptions shape the economy, but those perceptions are shaped by the Fed. The risks of moving too fast are especially high now, as the slump in G.D.P. and other economic indicators show that the economy is already slowing down. If the Fed hikes rates too high in this environment, it risks a recession.

The Fed is doing everything it can to achieve a “soft-ish landing,” which comes with risks. As we all know, the Fed can’t plant corn. It can’t make boats go faster. Essentially, Federal Reserve Chair Jerome Powell’s tool kit is lowering his glasses and sternly saying, “Hey, stop buying so much stuff,” in an attempt to normalize the forces of supply and demand.

The problem is, demand doesn’t need to slow down even further; that’s already happening. Instead, we need supply-side changes — more workers, more goods and more services — which require more than just monetary policy.

The vibes in the economy are … weird. That weirdness has real effects. A recent study found that broader vibes do indeed drive what people do, with media narratives about the economy accounting for 42 percent of the fall in consumer sentiment in the second half of 2021.

Indicators like G.D.P. are important, but much of the time, the root of economic problems lies with expectations. When we think about things like inflation, financial conditions and monetary policy, it’s best to frame them through people. And people are of course, silly and messy. Far too many economists and experts forget that the economy is really a bunch of people “peopling” around and trying to make sense of this world.

When policy is more focused on indicators that might not fully reflect reality, and not on the silly and messy people whom the policy is meant to serve, we enter dangerous territory.

There is no recession yet. Right now we are in a “vibe-cession” of sorts — a period of declining expectations that people are feeling based on both real-world worries and past experiences. Things are off. And if they don’t improve, we will have to worry about more than bad vibes.

Kyla Scanlon (@kylascan) founded the financial education company Bread and produces newsletters and videos about the economy. Before starting her own company, she worked at Capital Group and an education start-up.

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