Commentary: Consumer Confidence Is No Crystal Ball
Beware the fragile consumer!
That, it seems, was the message of Federal Reserve Board Chairman Alan Greenspan's testimony before Congress on Feb. 28, when he warned of the need to keep a sharp eye on the recent plunge in consumer confidence. But there's much less to fear from that drop than Greenspan's remarks suggest. In fact, using confidence as an economic predictor brings to mind the quip about the economist who correctly forecast nine of the past three recessions.
Conventional wisdom holds that declines in consumer confidence and expectations about the economic future mean big trouble ahead for the economy. But the data show that's not true: Consumer confidence and expectations are poor predictors of an economic contraction. In the past decade, consumer confidence fell by 25% or more four times--and only once, in 1990, did it herald a downturn.
ANOMALY? That 1990-91 recession, when the Iraqi invasion of Kuwait triggered a collapse of consumer confidence and spending, may have been a historical anomaly. Notes David A. Wyss, chief economist at Standard & Poor's Corp.: It "was the only recession in post-World War II history where consumption was the leading sector."
There's no question that the Consumer Confidence Index, as measured by the Conference Board, is a reliable gauge of how consumers feel. It tracks their moods with a questionnaire mailed to 5,000 households each month that asks about business conditions, employment, and family income as they exist now and as they are expected to be six months ahead. Results of this index, which is down 26% from May, 2000, closely match those of the other main indicator of consumer thinking, the University of Michigan's Consumer Sentiment Index, which uses a phone survey and a sample size of 500.
But a fall in confidence isn't even a sure sign that consumers will cut back on spending (table). Despite the 14% decline in confidence in 1998, for example, overall consumer spending rose 4.9%, and spending on durable goods jumped 23.9%. The conclusion: Spending is much more responsive to the tangible influence of jobs and incomes than to the ups and downs of confidence and expectations, which are affected by a slew of often temporary factors.
Instead of the confidence index, some economists prefer to focus more narrowly on consumer expectations about the economy's future performance. Indeed, the Conference Board's Expectations Index, a component of their broader confidence measure, does yield slightly better economic forecasts, according to research by Federal Reserve Bank of New York economists Jason Bram and Sydney Ludvigson. But that measure also comes up short: Consumer expectations are unreliable in forecasting recessions.
WRONG AGAIN. Forecasters argue that a fall in the expectations index below the level of 80 is "usually indicative of a recession," says Lynn Franco, director of the Conference Board's Consumer Research Center. Yet after the recession induced by the Iraqi war, that threshold was breached three times--and consumer spending and the economy continued to expand. In fact, four of the past five major declines in expectations--drops of roughly 25% or more--didn't even cause real consumer spending to fall. That suggests that there's no reason to panic over the expectations level of 68.7 found in the latest Conference Board survey.
The recent solid showing of retail sales, autos, and housing also indicates that spending can stay buoyant as expectations drop. Confidence and expectations may swing with reports of layoffs and talk of recession. But as long as unemployment stays tame, consumers are unlikely to throw in the towel.
By Charles J. Whalen
Whalen covers the economy.