As it turns out, the big economic story of 2023 is not a recession, as many had predicted — it’s the disconnect between consumer sentiment and behavior.

Higher than normal inflation over the past two years is an obvious reason that people would be down about the economy. The puzzle is why people are still behaving as if their economic situation is good. Inflation-adjusted consumer spending is way up: Not only above 2019 levels, but above the pre-pandemic trend. In fact, it’s largely the reason that US economic growth is above expectations. And yet consumer sentiment is at levels typically seen only in a recession.

All of which raises the question: What’s going on?

Economists tend to believe actions over words. You can insist that you prefer a vegetarian diet, but if you keep eating hamburgers, we will conclude that you actually prefer an omnivore diet. So if you say the economy is terrible but spend like it’s 1999, some economists will tend to trust what you do over what you say — and question the reliability of the polls.

These economists argue that the data showing a strong economy, including outsize consumer spending, imply that people are not being honest about how they feel about the economy. Instead, they are aligning their views with their political preferences. This argument maps on to the large disparity between Republican and Democratic views of the economy, a gap in attitudes that is not matched by a gap in their economic experience.

While inflation is the obvious pain point in the economy, it has also been substantially reduced — from a high of more than 9% last year to 3.7% today. Hopefully it will continue its decline, but the current rate is within historic norms for the US, and even a bit lower than it was in 2011.

This brings me to another common explanation for the disconnect between people’s anger and their behavior: It’s the prices, stupid.

Economists focus on inflation, the rate at which prices are rising. Consumers tend to focus on the actual prices themselves. The challenge is that, even with inflation under control, prices will stay high. This helps explain why 35% of Americans said in May that inflation and the high cost of living were their “most important financial problem.” And yet that very same inflation has also boosted incomes, which have risen even after adjusting for inflation. This may explain why Americans keep spending even as they complain about inflation.

People love to wax nostalgic about the good old days when everything was cheaper. Of course, wages were a lot lower back then too — but people rarely wax nostalgic about that. This kind of selective memory illustrates a concept called money illusion, which is the habit of judging some transactions based on nominal values rather than real ones. Money illusion makes people really hate inflation, even when it benefits them: It has contributed to the increase in the value of homes and investment portfolios, for example.

Then there is frequency illusion, the combination of selective attention and confirmation bias, which may be making it hard to recognize the fact of lower inflation. When inflation is low, which it was for much of the last three decades, our brains simply ignore it. Now that our brains are alerted to inflation, confirmation bias can lead us to look for it. And when some prices go up, as they always do, this bias makes them more salient. People end up believing that price increases are more common than they actually are.

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