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Econ 101

Considering the future

Spending drives our economy and that consumer spending accounts for more than two-thirds of annual total spending.
Growth in consumption spending is then tantamount to economic growth. When jobs are being created and personal incomes are rising, consumption spending tends to rise as well.

Job creation and earnings growth (average weekly earnings) can be tracked in the monthly “employment situation” release from the Department of Labor, which we discussed in the December 12th issue of the Mississippi Business Journal. That report, however, is backward-looking; that is, it reports what has occurred in the past. To gain insight into future consumer spending we must examine consumer attitudes toward the future.
There are two different independent forward-looking reports that are watched carefully by the financial markets: (1) the Conference Board’s consumer confidence index, and (2) the University of Michigan’s consumer sentiment index. (There are others, such as the ABC News/Washington Post Consumer Comfort survey, but they are not widely followed). Both of the major confidence/sentiment indexes are proprietary and require paid subscriptions for access to full details. However, monthly changes in the major indexes are widely reported in the business press and can be accessed from the respective web sites as well.

The belief that consumer attitudes help explain economic performance is really a result of the lingering Great Depression (1929-1941) when John Maynard Keynes noted that “animal spirits” were needed to pull the world out of the depression. To Keynes, animal spirits were the metaphor for consumer and business confidence and the lack of confidence was keeping consumers from spending and businesses from investing. President Franklin Roosevelt even noted in his first inaugural address “that the only thing we have to fear is fear itself…” (that is, a lack of confidence!). But are confidence indicators really useful in predicting the future?

Confidence and spending: is there really a link?

Before we discuss each of these surveys, it is important to examine the link between spending and confidence. We begin by noting that expectations regarding the future change before consumer behavior. It might be obvious that if consumers are worried about losing their jobs or a possible major external shock to the economy, they might reduce some spending (eating out, purchasing homes, cars, other durable goods).

On the other hand, it would not seem likely that consumer confidence would alter the decision to buy new shoes or food for the home. Indeed, studies have shown that changes in consumer attitudes are more likely to affect the sales of motor vehicles, other durable goods and services. But in a more general sense, just what does information about consumer attitudes tell us about the future of the economy?

The question often asked about consumer attitudes is just what additional information does a consumer attitude index add to the information already known about the economy?
For example, if we see interest rates rising, a falling stock market and the unemployment rate rising, does a falling confidence index add any additional information to the forecaster? Is confidence the result of, not the cause of, the decline?

Some studies have shown that consumer attitudes can in fact provide additional information that can improve our forecast of the future. But caution in attributing too much significance to rapid changes in month-to-month confidence indexes is urged. It is best to view confidence trends as a six-month moving average and as an indicator of consumer behavior six to 12 months in advance.

Conference Board’s Consumer Confidence

The Conference Board, a private non-profit business research organization, began the Index of Consumer Confidence in 1967. Currently, the survey consists of a mail questionnaire consisting of five questions sent to 5,000 U.S. households with a typical response of about 3,500. The confidence index is derived as the average of five index numbers developed for each question.

Two questions reflect consumers’ assessment of current conditions while three reflect their expectations of the future. A separate index of consumer expectations is included in the Index of Leading Economic Indicators (LEI), also published by the Conference Board. However the consumer confidence index is the index widely reported in the press. For more information, see www.conference-board.org.

Consumer sentiment and expectations

The University of Michigan began its consumer survey program in the late 1940s and is the oldest continuous consumer survey program. The survey consists of a telephone survey with about 50 core questions made to 500 households over the month. When a 50% response rate is reached, a preliminary report is released. At the end of the month, the preliminary release is revised. The following month, 60% new respondents are added with 40% continuing.

As shown in the chart, there is some volatility in the month-to-month reports suggesting that a six-month moving average of confidence would provide better information on potential trends in consumer spending.

The University of Michigan’s index of consumer expectations was selected to be part of the widely followed index of leading economic indicators starting in 1989 when it was published by the U.S. Department of Commerce.
The Index of Leading Economic Indicators, which we will discuss at the end of this series, was initially developed by the U.S. Department of Commerce, but has been published by the Conference Board since 1995.

Next time, we’ll take a look at retail trade and consumer credit.

Dr. William D. Gunther is professor of economics and director of the Bureau of Business and Economic Research in the College of Business at the University of Southern Mississippi. Contact him at mbj@msbusiness.com.

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