Rising Borrowing Costs: The Hidden Culprit Behind Consumer Sentiment Slump

📝 SUMMARY: In an intriguing development, researchers from the International Monetary Fund (IMF) and Harvard University, including Lawrence Summers, have released a paper that may shed light on the persistent gloominess of US consumer sentiment amidst an otherwise strong economy. The paper posits that the disparity between the healthy economic indicators and consumer mood can be attributed to the overlooked impact of elevated borrowing costs, particularly as the Federal Reserve has ramped up interest rates since March 2022 to curb inflation.

The cost of financing, an essential component of consumers' financial well-being, has not been adequately factored into economists' analyses, according to the paper. This oversight has led to a disconnect between the official inflation data, which does not include the cost of money, and the real cost of living perceived by consumers, who have increasingly turned to credit cards for purchases. The paper argues that this reliance on credit, combined with the rising cost to finance debt, has significantly contributed to the dampened consumer sentiment.

Furthermore, the paper critiques the current measures of inflation, like the Consumer Price Index (CPI), for excluding financing costs, such as those associated with purchasing a car or the interest on credit card debt. It proposes an alternative measure of inflation that incorporates the cost of money, which aligns more closely with the actual consumer sentiment.

The findings suggest a significant portion of the discrepancy between predicted and actual consumer sentiment can be explained by considering the cost of borrowing. This revelation prompts a reevaluation of the relationship between interest rates, inflation, and consumer mood, possibly indicating a shift towards a new economic paradigm where traditional models may no longer apply.

🔍 SOURCE: https://www.bloomberg.com/news/articles/2024-02-26/the-sting-of-higher-rates-could-help-unravel-consumer-sentiment-mystery