Borrowing costs weakened consumer sentiment in 2023

There are a boundless number of economic measures published and analyzable by economists and the public alike. However, both economists and consumers can face difficulty in deciphering why these measures may not necessarily agree. For example, though gross domestic product was high, inflation was falling, and employment was growing in 2023—consumer sentiment remained weak.

In “The cost of money is part of the cost of living: new evidence on the consumer sentiment anomaly” (National Bureau of Economic Research, Working Paper 32163, February 2024), authors Marjin A. Bolhuis, Judd N. L. Cramer, Karl Oskar Schulz, and Lawrence H. Summers state that U.S. consumer sentiment in 2023 was lower than should be expected and attribute lows in sentiment to borrowing costs and the consumer credit supply. To reach their conclusion, the authors use the University of Michigan Index of Consumer Sentiment (ICS), an alternative measure of consumer prices, and an examination of 10 advanced global economies.

As a result of high interest rates, which caused the cost of mortgage payments, car payments, and other credit payments to rise in 2023, banks were less likely to supply credit to consumers. The ICS readings indicate that consumer concerns about borrowing costs were at historic highs in 2023. The authors found a divergence of almost two standard deviations between actual ICS readings of consumer sentiment and what would be expected from a model that only uses inflation and employment. They attribute this gap to the increase in the cost of borrowing money.

In their research, the authors construct an alternative measure of consumer prices by incorporating borrowing costs into the measure, which narrows the gap between predicted and actual consumer sentiment. The measure reflects how borrowing costs and interest rates can affect the cost of living by capturing mortgage costs, consumer loans, lease prices for automobiles, and personal interest payments. By this measure, inflation reached a higher peak in the late 1970s and continued at a higher level when compared with the official Consumer Price Index (CPI). Their findings indicate that the 2023 consumer sentiment gap using their alternative measure would be about 75 percent smaller than the gap using official CPI data.

Finally, examining monthly data for 10 advanced Western economies from 1973 to 2023 shows that recent lows in consumer sentiment are not an issue unique to the United States. Low consumer sentiment is strongly correlated with the growth of interest rates and consumer concerns about borrowing costs across countries. The authors use a linear regression model and assess 10-year government bond yields, consumer price indexes, unemployment rates, stock market performance indexes, and the Consumer Confidence Index in their analysis for each country. The results indicate small gaps between expected and actual consumer sentiment in the United Kingdom and France while there were large differences between them in the United States, Germany, Austria, and Spain.