IF YOU ARE HAVING difficulty reading the conflicting signals coming out of the American economy, you are not alone. Consider this: An LA Times/Bloomberg poll shows that 78 percent of Americans think we are in an economic recession. A virtually simultaneous CBS News/New York Times poll found that 72 percent of Americans rate the financial situation of their households as "good." This reminds me of the old joke about the man who denies that he is having a relationship with another woman when his wife discovers them in bed together. "What do you believe, your own eyes, or what I tell you?" Apparently, Americans believe the media, which are telling them that there is a severe recession, even though their own eyes are telling them that things aren't so bad.

But don't blame it all on the media. There is good reason for confusion. Many homeowners are in or close to default, but the vast majority is not. A majority of the Federal Reserve's monetary policy gurus decided to lower interest rates at their last meeting, but a significant number of key members feel that inflation, not a recession, is the biggest problem the Fed faces. Banks report new write-downs, dropping more than one second shoe, but they also report that they have been successful in raising new capital to shore up their balance sheets.

Most confusing of all, the government reports that inflation is more or less under control. Core inflation--excluding food and fuel--rose only 0.1 percent last month. Good news--unless you eat or own a car.

Food eats up about 13 percent of household budgets, so when egg prices jump 40 percent over last year's level, milk prices go up 26 percent, and bread prices rise by 15 percent, household finances are strained. Gasoline is a less important component of household budgets, accounting for about 4 percent of total spending. But three circumstances make it an important inflation indicator for the average consumer.

First, consumers not only buy gasoline often, but pass giant signs proclaiming the new, higher prices several times every day. Second, the increase in prices has been extraordinarily rapid--from under $3 per gallon last year to about $4 now. No gradual adjustment is possible, only abrupt changes, such as deciding to leave the car in the garage this past weekend rather than watch the dizzying spin of the dial on the gas pump. Third, the knock-on effects are obvious: Among other things, airline flights are being eliminated to save fuel, fares are rising, and ancillary charges being invented, making that summer vacation more expensive.

There is something less obvious but more important than the dollar impact of this fuel and food inflation. It adds to Americans' sense that events are in the saddle and ride mankind. Prices are out of control; foreigners control the oil on which we depend and the price we pay for it; the dollar sinks, making overseas trips impossibly expensive; the president gets short shrift from robed rulers of a tiny kingdom that happens to sit on large reserves of oil; suicide bombers in cloth robes mock our armed-to-the-teeth soldiers in Iraq; China pays the higher oil and food prices but continues to produce goods far more cheaply than we can.

There's more, but you get the idea. As Cole Porter would have put it had he studied economics instead of music at Yale, after what some have called a not-so-quiet credit and buying spree, Americans find themselves fighting vainly the old ennui.

To make matters worse, Washington is somewhere between paralysis and dysfunctional. Some 70 percent of Americans disapprove of the way President Bush is handling his job, and an even larger percentage say Congress' performance is dreadful. Little wonder. Congressional committees made something of a spectacle of themselves last week by blaming oil company executives for high oil prices, while barring them from exploring for new reserves in Alaska and offshore California, Florida, and other states. Worse still, the farm lobby combined with liberal groups (the bill included the odd billion for anti-hunger programs) to persuade Congress to appropriate some $307 billion for mostly rich farmers whose incomes have already been driven skyward by the rising price of the foodstuffs they produce. The billions in handouts will flow even if food prices continue to rise. Bush, never known for his fiduciary relationship to taxpayers' money, promptly vetoed the raid on the Treasury, only to have his veto over-ridden by massive votes in both houses of Congress.

Almost fifty years ago, economist Mancur Olson pointed out that small, determined groups--what we now call special-interest groups--could push through measures that benefit them at great cost to society as a whole. He was right.

But a $14 trillion economy can tolerate a good deal of waste and still function quite well, and a new president with a fresh mandate should be able to eliminate the worst excesses if he chooses to do so. Meanwhile, the market and the actions of the Fed have reduced the likelihood that the credit crunch will result in a collapse of the financial system. Investors are buying up the dicey mortgages at a discount, and banks are raising new capital so they can return to the business of lending.

Most important, the credit and oil-price shocks are triggering needed reforms. Mortgage lenders will face new regulations, and banks new capital requirements. Consumers are switching en masse to more fuel-efficient vehicles and to public transportation. And more and more voters are registering to be in a position to let the current crop of politicians know what they think of them come November.

Irwin M. Stelzer is a contributing editor to THE WEEKLY STANDARD, director of economic policy studies at the Hudson Institute, and a columnist for the Sunday Times (London).

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