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. Consumer confidence is a catchall phrase that describes the opinions and attitudes consumers have about the economy's current and future strength.
The attention these indexes receive often centers on the potential information they contain regarding current and future economic conditions. In other words, changes in these indexes are often thought to foreshadow changes in economic conditions in broad terms.
The University of Michigan and the Conference Board both measure consumer confidence by asking five questions to a random sample of consumers. These questions cover individual sentiments regarding current and expected future conditions, as well as the individual's personal financial situation. After the surveys are conducted, the responses are aggregated into a single number called an index of consumer confidence.
The figure shows the Conference Board's Consumer Confidence Index measured from the late 1960s to the present, and the shaded bars indicate the time periods our economy has been in recession. As is evident from the figure, consumer confidence falls sharply whenever the economy goes into a recession, while it is at increasingly high levels during an expansion. Additionally, consumer confidence often peaks before the economy enters a recession.
Several research studies have investigated how much advance information consumer confidence indexes can provide. One study, by Philip Howrey, asked whether consumer confidence correlates to current economic conditions. He tested whether predictions of current-period consumption growth—the measure believed to be most closely related to consumer sentiment—can be improved by using results from the Michigan confidence index from that same period.
The answer to this question is important because consumer confidence reports are released at the end of the month measured, while most other economic data reports lag anywhere from a month or more. Thus, if the information inside consumer confidence reports truly is representative of current economic activity, then the reports would provide an early indication of the economy's strength. This study's results indicated that the indexes do provide some useful information for predicting the value of consumption growth; however, the improvement is generally small.
A second study, by Christopher Carroll, Jeffrey Fuhrer and David Wilcox, asked whether consumer confidence might predict future economic activity. This study tested whether the value of the University of Michigan index from the previous month—for instance, January—was able to improve forecasts for the next month's consumption growth—for instance, February. The study found that when consumer confidence is the only variable used in the forecast, it can significantly improve forecasts. However, once other widely available data are taken into consideration, consumer confidence increases the forecast's accuracy only marginally.
There's little question that today's consumer confidence indexes do give meaningful clues to the economy's strength; nevertheless, the data do not contain super-forecasting powers. If an economic forecaster had only consumer confidence data at her disposal and nothing else, she could use those measures to provide an educated guess about the economy's strength in broad terms. But we need to remember that the ability of consumer confidence to improve economic forecasts is modest at best, especially when considered along with other forecasting information.