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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? 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