Larry Summers Explains Why Americans Hate Joe Biden

Maybe not in exactly those words of course

As a good Democrat of course Larry Summers would never put things in quite that headline way. But the implication of this latest paper with others is to explain why Americans really aren’t as happy as they should be given the economic numbers. The answer being that the economic numbers we all look at to explain how happy folk are aren’t the right economic numbers to explain how happy people are.

We can also make - possibly rightly, possibly wrongly, this might be me projecting more than is merited - a further claim. That Americans simply aren’t as rich as those standard economic numbers suggest either. Which would also neatly explain the general down in the dumps attitude toward the economy.

So, the new paper:

Unemployment is low and inflation is falling, but consumer sentiment remains depressed. This has confounded economists, who historically rely on these two variables to gauge how consumers feel about the economy. We propose that borrowing costs, which have grown at rates they had not reached in decades, do much to explain this gap. The cost of money is not currently included in traditional price indexes, indicating a disconnect between the measures favored by economists and the effective costs borne by consumers. We show that the lows in US consumer sentiment that cannot be explained by unemployment and official inflation are strongly correlated with borrowing costs and consumer credit supply. Concerns over borrowing costs, which have historically tracked the cost of money, are at their highest levels since the Volcker-era. We then develop alternative measures of inflation that include borrowing costs and can account for almost three quarters of the gap in US consumer sentiment in 2023. Global evidence shows that consumer sentiment gaps across countries are also strongly correlated with changes in interest rates. Proposed U.S.-specific factors do not find much supportive evidence abroad.

OK, or as explained by the Telegraph:

In it, the authors made a shocking claim: if inflation was measured in the same way that it was measured during the last bout of price rises in the 1970s, data showed that it peaked at 18pc in November 2022. This is far higher than the 9.1pc peak inflation shown by the official data.

The reason for this discrepancy is that, since the 1970s, economists have removed the cost of borrowing from the Consumer Price Index (CPI). The motivations here were not nefarious. The reasoning of the statisticians had something to it.

And, OK, if inflation peaked at 18%, not 9%, then that would explain why folk are pissed. Sure it would.

Or, as one of the many bastards to have fired me over the years puts it:

Most notably, as Summers and his coauthors Marijn Bolhuis, Judd Cramer, and Karl Schulz point out, in 1983 the BLS eliminated interest costs from its calculations of consumer price inflation. The argument at the time, made by BLS economist Robert Gillingham, was that including home mortgage interest rates in the CPI formula was overstating inflation. Instead, Gillingham argued, the BLS should estimate what homeowners could charge if they rented out their homes, and use that to calculate housing inflation.

This change had a huge impact on the calculation of CPI, write Bolhuis et al., because the BLS removed housing prices and financing costs from the official CPI formula, even though everyday Americans still experienced those costs in the real world. “Owners’ equivalent rent”—the new CPI measure—amounts to over a quarter of the Consumer Price Index today.

Well, OK. That is really the difference between house prices and housing prices. Which to use is a matter of judgement more than anything else. As long as we’re consistent we can still compare over time.

But what Summers et al are pointing out is that we’ve not been consistent - the last time we had major inflation we did it with house prices, now we’re doing it with housing prices and so on. So, we can’t compare the consumer reaction then with now. And that’s the point they’re making, which is that the consumer reaction seems to be different this time around. Different if we assume that the inflation numbers have been calculated the same way. But, they haven’t: and when we do calculate them the same way then the consumer reaction - how pissed everyone is - is the same and makes sense.

Well, OK.

But now me extrapolating - as above, perhaps rightly or wrongly.

So, GDP basics. Nominal GDP is, well, it’s nominal. We measure it in “current dollars” or what a dollar is worth in the year of the economy we’re measuring. Real GDP is correcting for the change in the value of a dollar over a or many years - correcting for inflation. It’s real GDP that matters, not nominal. Zimbabwe was doing great by nominal GDP, indeed doing ever better as it hurtled through hyperinflation to bankruptcy. Real GDP matters because that’s what measures how much people can have from their having gone out to work that year.

OK. But that means that if inflation was higher than we’ve been using then the deflation of nominal to real GDP is also wrong. Just that one year of 9% recorded but 18% by this new measure is damn near a 10% difference. That’s how much we’re over-estimating real GDP by right now. Add in a couple of years of lower levels of that and being 20% out wouldn't surprise.

Which would mean that - if this were true and I might be overegging it - Americans are in fact 20% poorer than the Biden Admin keeps saying they are. And yes, that would piss the voters off, wouldn’t it?