The 'Vibescession' Will Continue Until Interest Rates Fall

A new economic paper explains why interest rates are the missing piece to understanding why people are unhappy about a seemingly strong economy.

In the mid-1840s, astronomers noticed a strange wobble in the path of the planet Uranus as it revolved around the sun.

Some theorized that such a wobble could only be caused by another large gravitational field pulling on Uranus. They did a bunch of complex math applying Isaac Newton's theories of gravity, pointed their telescopes at a spot in the sky where the missing planet should be, and boom—that's how humans confirmed the existence of Neptune.

For political economists, 2024 is now the mid-1840s and President Joe Biden's approval ratings (and reelection chances) are the orbit of Uranus around the sun. A new paper from three economists at Harvard and one based at the International Monetary Fund proposes to have found the missing planet that's exerting a significant pull on the expected sequence of events.

"Unemployment is low and inflation is falling, but consumer sentiment remains depressed," the economists write, noting that this series of events "has confounded economists, who historically rely on these two variables to gauge how consumers
feel about the economy."

Indeed, by the traditional view, Americans should be thrilled about the state of the economy. Inflation remains higher than normal but has slowed considerably since peaking in the summer of 2022. Wages have consistently outpaced inflation every month since last May. The so-called "soft landing" from inflation seems to have been achieved without tipping the country into recession. Low unemployment means that workers have considerable leverage to seek raises and better jobs—and can take refuge in the knowledge that finding another job will be relatively easy if they do get laid off.

And yet, most Americans remain sour about the state of the economy. According to a Gallup poll from last month, 45 percent of Americans rate the country's economic conditions as "poor"—a far larger share than those who rate it as "excellent" (5 percent) or "good" (22 percent). As bleak as those figures are, that's actually a slight improvement over similar Gallup polls from late 2023.

Unsurprisingly, since many people vote with their wallets, Biden's approval ratings and scores on questions about his handling of the economy—with the usual caveats about how presidents don't possess dials that control such things—remain well underwater.

So what's up? Where is the mystery planet tugging on Americans' view of what would appear to be a strong, growing economy?

The four authors of the new paper—one of whom is Harvard's Larry Summers, who tried unsuccessfully to warn the Biden administration against passing a $2 trillion stimulus bill in early 2021 because he feared inflation would be the result—point their metaphorical telescopes at interest rates.

The cost of borrowing money, they explain, "is not currently included in traditional price indexes, indicating a disconnect between the measures favored by economists and the effective costs borne by consumers." With inflation rates hitting 20-year highs in the wake of the pandemic, everything from mortgage payments and car payments to the interest costs charged by credit cards have shot upward, and that is undeniably putting a drain on Americans' wallets.

For Summers and the rest, this explains a significant portion of what some analysts have referred to as a "vibescession"—the vague but persistent sense that things aren't going as well as prominent economic indicators suggest.

As a practical matter, the economists suggest that interest rates should be taken into account when measuring things like consumer sentiment about the economy: "The inclusion of borrowing costs into an alternative measure of CPI inflation significantly narrows the gap between predicted and actual consumer sentiment," they conclude.

More generally, this theory might explain a lot. The sticker shock of higher prices at the grocery store might have waned, but higher interest rates impact Americans in a lot of ways that aren't quite as obvious. In 2018, the average monthly payment on a new car was about $530. Last year, it was over $720. Some of that increase is due to inflation in the price of vehicles, but a sizable chunk is due to interest rates being significantly higher. An extra $190 a month is a lot. It might cause some Americans to put off a planned purchase of a new car in the hopes that rates will fall—I've done that—or feel like such a purchase is unaffordable.

There's another factor at work too. Interest rates had been remarkably low for a long time until recently. Anyone younger than Gen X has never dealt with mortgage rates or loan rates approaching their current levels. Mortgage rates remain well below where they were when my parents were buying their first home in the early 1980s—rates peaked around 18 percent back then—but that is utterly meaningless to people who have seen mortgage rates nearly triple since 2020.

In short: The "vibescession" is not just a reflection of how inflation has sapped the buying power of the dollars in your wallet. It's that higher interest rates triggered by inflation have made it much more expensive to obtain the necessary dollars to make big purchases. Americans feel, correctly, that those big things are farther out of reach—and might feel more burdened by routine things like credit card purchases too.

Chalk up another reason why inflation is a dangerous beast to turn loose, and why those encouraging Biden to run the economy "hot" were playing with fire. Long after price hikes have slowed, the costs of the recent inflationary run are still being felt.

Perhaps one bit of good news: The four economists found that Americans are reacting pretty normally to all this. "We find little evidence that the United States, despite its rising partisanship, social distrust, and large reported levels of overall 'referred pain' differs meaningfully from other Western democracies," they write. "Consumers are digesting economic data in a way that is consistent with consumer sentiment during previous bursts of high inflation and increasing interest rates."

The vibes created by higher interest rates, it turns out, are a bit like gravity: easily felt, more difficult to measure. It's an invisible force, one best observed by recognizing the consequences it exerts on other things, like nearby planets and presidential approval ratings. And if used correctly, it might point your gaze toward a missing piece of the picture.