The Reuters/Michigan index of consumer sentiment tumbled four points in April. Could just be measurement noise, or could be that something new is pressing down on consumers.
Bill McBride notes that one reason consumer sentiment remains low is that unemployment remains high. He graphs unemployment on an inverse scale below to emphasize the correlation. But with no further deterioration in unemployment, why would consumer sentiment be falling again?
Bill suggests the answer may be the recent uptick in gasoline prices, which he again plots on an inverse scale below (with gas prices deflated by the CPI).
A recent study by Paul Edelstein and Lutz Kilian (published version here, working paper here) estimated a simple model of the relation between energy prices and consumer sentiment. For current expenditure patterns, their model implies that a 1% increase in the relative price of energy will over time be associated with a half-point drop in the index of consumer sentiment. In a recent study in the Brookings Papers on Economics Activity (published version here, working paper version here), I used their model as estimated using data over 1970:M1 to 2006:M7 to simulate to contribution of energy prices to consumer sentiment over 2007:M9 to 2008:M9. According to the historical correlation, the 20% increase in the relative price of energy over this episode would have been predicted to result in about a ten point drop in the index of consumer sentiment, suggesting that energy prices were one factor, though certainly not the only factor, contributing to the drop in consumer sentiment observed in the first year of the downturn.
Between October 2009 and February 2010, relative energy prices as measured by Edelstein and Kilian rose 5%, and the gasoline price increases seen since could bring the cumulative change to about 8% by now. So the latest four-point drop in consumer sentiment could just be noise. On the other hand, it’s exactly the size of the effect we would expect the recent run-up in energy prices to have.