Consumer confidence: does it lead or lag the economy?
Published January 1, 1993 | January 1993 issue
When consumer confidence falls, the business community grows nervous. But when consumers report feeling good about their own and the nation's economic well-being, sales are expected to rise, stimulating employment and economic growth.
A wide range of business and economic policy-makers take consumer attitude surveys very seriously. At the beginning of 1989, the Bureau of Economic Analysis of the U.S. Department of Commerce revised its Index of Leading Indicators to include the Index of Consumer Expectations, an indicator of how well-off consumers expect to be in the future relative to today. The Data Resources Inc./McGraw Hill (DRI) model of the macro economy uses consumer survey data to effect decisions about housing, claiming that it indirectly affects virtually all other sectors of the economy. The Federal Reserve Board, which controls monetary policy, regularly considers reports about consumer attitudes along with many other phenomena affecting economic growth.
There is, however, considerable confusion about just what these consumer attitude surveys really measure and what they mean for future spending. This stems, in part, from the existence of at least two consumer attitude surveys reported in the press that measure slightly different things. The most commonly reported is the Consumer Confidence Index, compiled by the Industrial Conference Board. It measures the willingness of consumers to make major purchases in the very near term, as does the Index of Current Economic Conditions. The latter is one part of the also widely reported Consumer Sentiment Index, which is compiled by the Survey Research Center of the University of Michigan. The second part of the Consumer Sentiment Index is the Index of Consumer Expectations, which measures how well-off consumers personally expect to be in the future and whether they believe national business and economic conditions will improve.
Interpreting the meaning of the Consumer Sentiment Index is complicated because its two components indicate different spending behavior. When consumers report that they expect to feel better off in the future, current expenditures stagnate as consumers delay purchases until a better time. When they feel relatively well-off today, consumers buy now, boosting current consumer expenditures.
There are three major opinions about the usefulness of these indexes and how they function. One, which reflects the underlying assumption of the original surveys, suggests that consumers' attitudes and subjective expectations respond to a variety of information and change before buying behavior changes. Thus, consumer sentiment can change directions independent of observable economic phenomena and will lead changes in the economy.
The second opinion is that, at least in normal economic and political times, consumer attitudes simply reflect economic prosperity or adversity and therefore tend to follow observable economic trends.
A third view is that attitude data best measure the degree of uncertainty consumers are feeling. As uncertainty increases, consumers tend to hold their assets in more liquid forms, decreasing spending on durable goods and creating an observable effect on aggregate consumption and long-term investment.
Two sources of uncertainty shown to affect consumers' future expectations are inflation and unemployment. The policy of the Federal Reserve Board to hold down inflation should, then, be correlated with higher consumer expectations about future well-being. But, expecting stable prices, consumers do not rush to buy durable goods in order to beat expected higher prices. Low inflation is a good policy for steady economic growth, but it will not inspire consumers to jump-start the economy.
The usefulness of these indexes of consumer attitudes in predicting future consumer spending has been debated and researched, debunked and praised. Most economists who have tried to incorporate these indexes into their forecasting models have found them to add little to what they already know from other economic data, except in times of great uncertainty, like the 1990s.
Attitudes about current well-being seem to be more useful in predicting consumer spending than future expectations, but forecasting models do not seem to produce consistent results with all scenarios. For the economic forecaster, it is a little like having a mild case of the common cold. You can't afford to ignore it, yet it doesn't seem to change things very much.
Over the past two or three decades these consumer attitude surveys have gained considerable credibility. They provide a very good summary of consumers' perception of the current state of the economy. Consumers' confidence or uncertainty can be affected by a lot of things, such as political news or media personalities, that are not captured by aggregate economic data. It behooves us to watch the various consumer attitude surveys carefully. They are one good indicator of our economy's health.