Your Political Opinions are Costing you Money
The question ‘how is the U.S. economy doing?’ is an objective and non-partisan one, right? Wrong. A recent study by Pew Research suggests that how we view the economy is deeply connected to our political opinion and is often unrelated to how the economy is actually doing.
As the chart below shows, who holds the presidency has a far greater effect on how we view the economy than GDP growth. This is true for Republicans under the Clinton and Obama administrations, as well as for Democrats during both the Bush and the Trump administrations.
New research on behavioral economics and decision making theory suggests a few answers for why our view of the economy is so greatly affected by our political views. In his important book Thinking Fast and Slow, the noble prize winning economist Daniel Kahneman suggests that humans often use heuristics — quick and practical but not always accurate methods — to answer difficult questions. One very common heuristic is that of substitution. According to Kahneman, “this is the essence of intuitive heuristics: when faced with a difficult question, we often answer an easier one instead, usually without noticing the substitution”.
In the case of economic conditions, most people are unequipped with the data and frameworks required to make sound assessments of the state of the economy. Instead, when asked about the economy, they subconsciously substitute the question with a different question like ‘how do I feel about the person responsible for economic policy?’ or ‘how do I think will the current administration’s actions affect the economy?’. Naturally, political opinions have a much larger effect here.
A second heuristic at play here relates to where and how we gather our information. Kahneman suggests that “people tend to assess the relative importance of issues by the ease with which they are retrieved from memory — and this is largely determined by the extent of coverage in the media”. Since media coverage is increasingly partisan, it is not surprising that within their respective echo-chambers, each political side will be exposed to information that diminishes the achievements of the other party.
How individuals view the economy is not merely an academic question, but one that has large implications on individuals’ finances and the economy itself. For starters, if individuals believe that the economy is doing poorly, they are less likely to invest in risky assets like public equities. Yet sitting on the sidelines during the Obama administration that saw a 182% growth in the S&P 500 would have been a poor choice for Republicans. The same is true for Democrats under the Trump administration, during which the S&P 500 saw an increase of 32%.
A second effect of how we view the economy relates to individual consumption. Individuals who view the economy as doing poorly are likely to curb their individual consumption. In an economy like the U.S., where 68% of nominal GDP is driven by private consumption, this can have a real impact on growth, making the prophecy of a bad economy self-fulfilling.
With the increasing politicization of the Fed and polarization of the country, separating facts from narrative is becoming harder and harder. Still, we should all make an effort to check our biases and strive to make financial decisions that are grounded in data.
– AD
