Full text of Inside the Vault : Spring 2003

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2/20/2020

Does Consumer Confidence Measure Up to the Hype?

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Does Consumer Confidence Measure Up to the
Hype?
Every month, the two primary measures of U.S. consumer confidence, the University of Michigan’s Index of
Consumer Sentiment and the Conference Board’s Consumer Confidence Index, are released with much
media fanfare. The attention these indexes receive often centers on their potential to provide more
information regarding current and future economic conditions - and the belief that changes in the two indexes
may foreshadow changes in general economic conditions.

What Is Consumer Confidence and How Is It Measured?
“Consumer confidence” is a catchall phrase for the opinions and attitudes of consumers about the current and
future strength of the economy. As a psychological concept, consumer confidence is difficult to measure. The
University of Michigan and the Conference Board both measure consumer confidence by asking a random
sample of consumers five questions about current economic conditions and expected future conditions
(below). Consumers also are asked to evaluate their personal financial situation.
After the surveys are conducted, the responses are compiled into a single number, called an “index” of
consumer confidence. Changes in this index are meant to measure changes in overall consumer confidence.
Interestingly, consumer confidence appears to correlate with the strength of the economy at the time of the
survey. When the economy goes into a recession, consumer confidence generally falls sharply. When the
economy expands, consumer confidence generally rises to high levels, often peaking before the economy
enters a recession.

What’s All the Fuss About?
One reason why people might pay so much attention to consumer confidence indexes is because they may
provide an early signal regarding the strength of the economy. These survey data are released very quickly—
in most instances long before other data measuring the strength of the economy are released. For example,
the consumer confidence indexes for a given month are generally released toward the end of that month. In
contrast, the personal consumption expenditure report, which measures what consumers actually did that
month, is not available until the end of the following month. Thus, because consumer confidence is timely, it
could be a useful early indicator of the economy’s performance.
A second way in which the consumer confidence survey information might prove useful is if responses to
survey questions provide good forecasts of future economic activity. Consumer confidence serves as a
convenient summary of the forecasts of many individuals based on a variety of information. Who knows?
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Does Consumer Confidence Measure Up to the Hype?

Consumers might be good at forecasting the economy. To the extent that these forecasts are useful for
predicting economic activity, indexes of consumer confidence can serve as a leading indicator of the
economy’s strength.

When Trapped on a Deserted Island
Many research studies have attempted to determine if consumer confidence is a useful early signal of
economic activity. Economist Phillip Howrey of the University of Michigan tested whether predictions of
current period consumption growth can be more accurate by using results from the Michigan confidence index
from that period. Howrey concluded that the Michigan index does provide some useful information for
predicting the value of consumption growth, although the degree of improvement is generally small.
What about the possibility that consumer confidence might predict future economic activity? Several
economists tested whether the value of the University of Michigan index from a month, say, January, was able
to improve projections of February’s consumption growth. They concluded that when consumer confidence is
used as the only variable, it can significantly improve these forecasts.
Thus, if an economic forecaster were trapped on a deserted island with only data on consumer confidence,
use of the consumer confidence measures to educate her guess about the economy’s strength in general
would not be a bad idea. However, consumer confidence is not data with “super-forecasting” powers.
Nonetheless, these data get super attention each month when they’re reported.
This article was adapted from “Consumer Confidence Surveys,” which was written by Jeremy Piger and
appeared in the April 2003 issue of The Regional Economist, a St. Louis Fed publication

The University of Michigan’s Survey Questions
1. We are interested in how people are getting along financially these days. Would you say that
you (and your family living there) are better off or worse off financially than you were a year
ago?
2. Now, looking ahead, do you think that a year from now you (and your family living there) will be
better off financially, worse off or just about the same as now?
3. Now turning to business conditions in the country as a whole - do you think that during the next
12 months we’ll have good times financially, bad times, or what?
4. Looking ahead, which would you say is more likely: that in the country as a whole we’ll have
continuous good times during the next five years or so, or that we will have periods of
widespread unemployment or depression, or what?
5. About the big things people buy for their homes - such as furniture, a refrigerator, stove,
television and things like that - generally speaking, do you think now is a good or bad time for
people to buy major household items?

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Q&A

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Q&A
Wouldn't anyone gain from deflation?
Those with fixed money incomes would find their real incomes enhanced even without a change in their
nominal incomes. And savers would find the purchasing power of their savings has grown - assuming those
savings are in fixed-value monetary assets - because of the falling prices of goods and services.

So, some people are better off and some worse off during periods of deflation?
The fact that any given family may be an income earner, a holder of financial assets, an owner of real assets
and a holder of debt simultaneously would probably cushion the redistributive impact of deflation. If the family
owns fixed-value monetary assets such as savings accounts, deflation would increase their real value. As a
holder of debt, a family would be repaying that debt with more valuable dollars. In addition, that same
deflation may decrease the real value of any property assets such as a house or land that the family owns.
Thus, many families could be simultaneously hurt and helped by deflation.

Is deflation worse than inflation?
Both deflation and inflation cost the economy in terms of output. Both also hurt business investment and may
adversely affect families. The Federal Reserve is committed to maintaining price stability because it is
necessary for sustainable long-term economic growth.

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Economic Snapshot

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Economic Snapshot

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Economic Snapshot

3rd Quarter 2004
Q4-03 Q1-04 Q2-04 Q3-04
Growth Rate—Real Gross Domestic Product

4.2%

4.5%

3.3%

3.7*

Inflation Rate—Consumer Price Index

0.7%

3.6%

4.7%

1.9%

Civilian Unemployment Rate

5.9%

5.6%

5.6%

5.4%

*Advance estimate

Graph from February 2003 issue of National Economic Trends.

What is the difference between the CPI and the PPI?
The Producer Price Index (PPI) is a family of indexes that measures the average change over time in selling
prices received by domestic producers of goods and services. The PPI measures price change from the
perspective of the seller.
PPIs contrast with other measures, such as the Consumer Price Index (CPI), that measure price change from
the purchaser's perspective. Sellers' and purchasers' prices may differ due to government subsidies, sales
and excise taxes, and distribution costs.

Why have goods prices risen so much more slowly than services
prices?
Tremendous advances in technology and productivity in goods production have produced cost savings in
manufacturing.

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