How Gas Prices Get in Our Heads

One of the defining characteristics of the second half of 2023 has been the gloominess of American consumers. Even as the economy remained unexpectedly robust—growing at a 5.2 percent clip in the third quarter—and inflation cooled, consumer sentiment as measured by the University of Michigan’s Consumer Sentiment Index dropped steadily from the summer through the fall, and its rating hit a low of 61.3 in November.

But then something surprising happened. In the December survey, released last week, consumer sentiment spiked upward by 13 percent, rising to 69.4, making up pretty much all the ground it had lost since August. Even more striking, consumers’ expectations of inflation over the year ahead fell dramatically, tumbling from 4.5 percent all the way to 3.1 percent. That finding ambushed analysts, who had forecast a trivial bump in sentiment. And Americans’ new, better mood could not be explained by the decline in overall inflation, which fell just a tenth of a percentage point last month.

One change could account for why people might be feeling more buoyant: Gasoline prices have been plummeting. According to the American Automobile Association, the average gas price nationally is about $3.10 a gallon, down from $3.83 a gallon in September; and about 60 percent of gas stations are now selling gas for less than $3 a gallon.

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That drop matters not just because of the economic impact of cheaper gasoline, but because no other product’s price has such an outsize effect on consumer sentiment. In a recent paper, for instance, the economists Carola Binder and Christos Makridis looked at the impact of gas prices on Americans’ feelings about the economy as measured by the Gallup Daily tracking survey, which from 2008 to 2017 asked roughly 1,000 adults a day the same two questions that are used to build something called the Economic Confidence Index.

Binder and Makridis found that increases in state gas prices made people more pessimistic about the national economy, regardless of what else was happening economically at the state or national level. They also noted that the response was very quick—negative sentiment peaked three days after a meaningful rise in gas prices.

This fits with previous studies of the relationship between gas prices and public sentiment. A 2012 study found not only that gas prices were negatively correlated with consumer sentiment, but that the relationship was causal: In other words, changes in gasoline prices led consumer sentiment. Higher gas prices have also historically been strongly correlated with presidential approval ratings. And an older study by Carol Graham and Soumya Chattopadhyay of the Brookings Institution showed that rising gas prices actually depressed Americans’ level of happiness.

Few things in life, it turns out, can make us feel gloomier than a spike in gas prices can. But on the flip side, judging from the new consumer-sentiment numbers, few things can make us feel more optimistic than falling gas prices.

This is in part because of the impact of gasoline prices on people’s pocketbooks. According to one study, people with longer commutes were more likely to hold the president accountable for rising gas prices. But it isn’t just about money: The drop in prices since August, for instance, has saved the average American driver maybe $20 to $30 a month. That’s not trivial, but it’s not a big enough boost to justify the spike in consumer sentiment we just saw.

The psychological impact of rising gas prices, then, is greater than their actual economic impact. Why? Well, the demand for gasoline is, at least in the short run, inelastic: People can’t significantly reduce the amount they drive in response to higher prices. And there is no substitute for gas: You can’t fill your tank with olive oil. So rising prices make people feel trapped and deprived of the ability to control their spending.

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More important, because every gas station lists its numbers on a huge sign, the price of gas is impossible to avoid: Just driving around town means being bombarded with reminders of how much gas costs. When prices are rising, that’s guaranteed to bring you down. But when prices are falling, as they are now, you’re getting a subliminal message that things are improving.

We know from behavioral economics that when we form opinions or make decisions, we tend to focus on information that’s memorable and comes easily to mind, while ignoring less attention-grabbing data. And when it comes to the economy, nothing is more in your face than gas prices are.

Falling gas prices are good news for Joe Biden—which is presumably why Donald Trump gave a speech the other day in which he claimed that gas costs “$5, $6, $7, even $8 a gallon.” But the substantive lesson of the big spike in consumer sentiment is just how much psychological perception can shape our view of the economy. If America’s going to get out of its “vibecession,” lower gas prices are probably the way to start.