macroeconomics, consumer, durable spending

George Katona

English

Research Papers in Economics

GEORGE  KATONA* 
The University  of Michigan 
A  Communication: 
Consumner  Durable 
Spending 
WE  AT THE SURVEY  RESEARCH  CENTER  were greatly pleased to find in- 
cluded  in Brookings Papers on Economic Activity a study  that "appraises 
the contribution  of the Survey Research  Center's  Index of Consumer 
Sentiment  to forecasts  of automobile  demand."'  Saul Hymans  makes a 
valuable  contribution  in attempting  to incorporate  the consumer  sentiment 
variable  in a stock  adjustment  forecasting  model  and  thus  to bridge  the gap 
between  econometrics  and the analysis  of psychological  factors  relevant 
for consumer  behavior. But certain procedures  used by Hymans and 
numerous  remarks  made by him and the discussants  call for a reply by 
those who have measured  the changes  in consumer  sentiment,  so that the 
reader  may be given  a fuller  understanding  of the issues  raised. 
Hymans  searches  for economic  variables  that may be substituted  in re- 
gression  equations  for the index of consumer  sentiment.  He finds that a 
combination  of three  variables-earlier  changes  in real  disposable  income, 
in common stock prices, and in consumer  prices-"taken together  with 
the lagged  index . ..  explain  nearly  80 percent  of the variation  in [the in- 
* I am grateful  to my colleagues  Jay Schmiedeskamp  and Burkhard  Strumpel,  whose 
suggestions  contributed  to this paper. 
1. "Editors'  Introduction,"  Brookings  Papers  on Economic  Activity  (2:1970), p. 164. 
Page numbers  in the text of this communication  refer  to Saul H. Hymans, "Consumer 
Durable Spending:  Explanation  and Prediction,"  and to the discussion that follows it 
(pp. 173-206 in the same journal). 
234 George  Katona  235 
dex]" over the period 1956 to 1968 (p. 176). By substituting the explanatory 
variables for the index, Hymans predicts index values for 1971 and 1972. 
The index itself is said to  contribute to  forecasts of auto demand for a 
couple of quarters, primarily in a filtered form as suggested by Thomas 
Juster.2 The following observations are in order.3 
1. The construction of the index stems from a model of human behavior 
that postulates that the response (R-for  example, changes in certain forms 
of consumer spending or saving) is not a function of the stimulus alone (S, 
consisting, for instance, of  information received on changes in income, 
prices, supply conditions). Intervening variables (1), such as people's mo- 
tives, attitudes, expectations, and aspirations, influence the perception of 
S as well as R. Changes in I occur earlier than changes in R. The role of I 
in consumer behavior is particularly powerful in an affluent economy in 
which the majority of  consumers have some discretion of  action. Con- 
sumers' discretionary expenditures  (on cars, housing, leisure-time pursuits, 
and so on) are a function of both their ability and their willingness to buy. 
Movements of the index of  consumer sentiment are intended to  reflect 
changes in I  and therefore in willingness to  buy. They serve to  indicate 
changes in the direction of prospective discretionary expenditures. For the 
purpose of  forecasting the  extent of  discretionary expenditures, a joint 
measure of ability and willingness to buy, the product of the index and 
income, has been developed. 
Personal experiences and information received on economic matters in- 
fluence changes in willingness to buy. The underlying model of behavior 
postulates that the factors bringing about a change in intervening variables 
vary from time to  time. While changes in I  are measurable, and these 
measures help to predict R, the relation of Ito  S is much more complicated. 
The specific  items of experience or news that are primarily  responsible for a 
change in consumer attitudes and expectations at a given time, and the 
influence they exert, are not known in advance, although they can be de- 
2. See National Bureau  of Economic  Research,  1970  Annual  Report,  p. 42. The filtered 
index was used by Juster  in the quarterly  forecasts  published  by the Commercial  Credit 
Company. 
3. The observations  are  based  on the following  publications:  George  Katona,  Psycho- 
logical  Analysis  of Economic  Behavior  (McGraw-Hill,  1951);  Katona, The  Powerful  Con- 
sumer  (McGraw-Hill,  1960);  Katona, Mass Consumption  Society (McGraw-Hill,  1964); 
G. Katona, B. Strumpel,  and E. Zahn, Aspirations  and Affluence  (McGraw-Hill,  1971); 
and annual monographs  entitled Survey  of Consumer  Finances,  published  by The Uni- 
versity  of Michigan,  Institute  for Social Research,  Survey  Research  Center. 236  Brookings Papers on Economic Activity, 1:1971 
termined  after  the change  in attitudes  is known.  Therefore  we rely on the 
consumers,  interviewed  at quarterly  intervals,  to provide  information  on 
how S influences  I and  therefore  R, rather  than  searching  for "candidates" 
that are "systematic  and  measurable  determinants  of changes  in consumer 
mood"  (p. 175). 
A large  part of each of our quarterly  surveys  is devoted  to discovering 
why the index  has moved  up or down at a given  time.  For instance,  in the 
first  half of 1969 inflation  and disappointment  about the continuation  of 
the war in Vietnam,  in contrast  with some optimism  generated  by the 
opening  of the Paris  negotiations  in 1968, played  a large  role in making 
consumers  apprehensive.  In the second  half  of 1969  and  in 1970,  unemploy- 
ment  and  layoffs,  as well as high  interest  rates,  were  identified  as the major 
adverse  news.  To be sure,  there  are  perennial  issues,  but their  impact  is not 
systematic.  Only  data  on perceptions  and  attitudes  indicate  whether  income 
increases,  for one example,  are felt to be satisfactory  and therefore  will 
exert a stimulative  influence,  or, for another,  whether  price  increases  are 
felt strongly  enough  to depress  sentiment. 
If it is true  that changes  in consumer  sentiment  often originate  in differ- 
ent considerations  in consecutive  periods,  then a satisfactory  fit resulting 
from the use of specific  variables  in a past period  cannot  be expected  to 
insure  success  with the same  variables  in the future. 
2. The predictive  value of the index should  not be evaluated  solely on 
the basis  of its performance  over  the entire  twenty  years  for  which  the index 
is available,  because  they cover  two kinds  of periods.  There  are  periods  in 
which the prevailing  trend continues  (for example,  1963-65) and others 
that are characterized  by turning  points (1957-58 and 1969-70).  In the 
first  kind  of period  a naive  model  predicting  that "tomorrow's  weather  will 
be the same  as today's"  would  have  yielded  correct  predictions.  Even  under 
these  circumstances  scientific  forecasting  has  an  important  function  because 
it is known  only  post  hoc that  the economic  trend  would  not change.  Never- 
theless, only for periods of substantial  change, and especially  for those 
crucial  periods  in which  the direction  of consumer  activity  shifted,  can it 
be demonstrated  that attitudinal  data  did indeed  foreshadow  large  changes 
in the economy  and were  indispensable  for that purpose. 
As an illustration  of the predictive  value  of attitudes  in the crucial  period 
of the last  two years,  the index  began  to decline  as early  as May 1969  (prior 
to the downturn  on the stock  market).  It fell precipitately  in the third  and 
fourth  quarters  of 1969 and declined  moderately  in the first and second George Katona  237 
quarters  of 1970 (when stock prices  fell sharply).4  The joint measure  of 
ability  and willingness  to buy declined  all through  1969,  but was substan- 
tially stable  in 1970.  In 1969-70,  as in some other  earlier  crucial  periods,  a 
prediction  of the index  or of auto  demand,  based  on "real"  variables  rather 
than on the index, appears  to be less satisfactory  than it is over a longer 
span that includes  years  in which  the prevailing  trend  continued. 
3. Similarly,  a  stock adjustment  model may be most applicable  in 
periods  in which  consumer  sentiment  has not changed  much.  Calculations 
of the relation  of actual  auto stock  to desired  stock  become  problematical 
when there are great  changes  in sentiment  and in economic  trends  that 
make for changes  in the desired  stock.  The relation  of car demand  in the 
recent  past, from  which  the actual  stock variable  is derived,  to future  de- 
mand  is very  complex:  Low  automobile  demand  in a given  period  may  stem 
either  from  a reduction  of the desired  stock or from  postponement  of pur- 
chases  under  the impact  of what  is felt to be a temporary  adverse  develop- 
ment.  Large  auto sales  in a given  year  may  result  in saturation  but, alterna- 
tively,  wants  and aspirations  may grow  with accomplishments. 
These  considerations  do not imply  that we should  be satisfied  with the 
simple  equation  used by the Survey  Research  Center  in the past, which 
relies on just two explanatory  variables  (the index and past income, or 
changes  in these  two variables).  Even  though  the index  is not well designed 
to be used in a stock adjustment  model,  work on its appropriate  transfor- 
mation and its inclusion  in a more sophisticated  model should  continue. 
This is, however,  not the place to present  attempts  to overcome  what 
Hymans  calls the "dichotomy"  between  econometric  and psychological 
studies. 
4. Some form of a filtered  version of the index is justified  because, 
naturally,  there  were  many  quarters  during  the last twenty  years  in which 
the changes  in the index were not statistically  significant.  (A difference 
between  two successive  index values of 1.3 points is significant  at the 67 
percent  level,  and  of 2.6 points  at the 95 percent  level.)  Juster  and Hymans 
go much  further  by proposing,  in essence,  to disregard  all but rather  large 
changes  in the index,  and also to disregard  changes  in one direction  in one 
quarter  if followed  by changes  in the reverse  direction  in the next quarter. 
An alternative  solution  to this problem  is reliance  on small  index  changes 
4. The index  of consumer  sentiment  (February  1966 =  100)  stood at 95.1 in February 
1969, 91.6 in May, 86.4 in August, 79.7 in November,  78.1 in February  1970, and 75.4 
in May 1970. 238  Brookings Papers on Economic Activity, 1:1971 
(a) when they result  from changes  in most rather  than a few index com- 
ponents, and (b) when answers  to other relevant  questions,  not yet in- 
corporated  in the index  but fully  reported  by the Survey  Research  Center, 
support  the change  in the index.  In addition,  the level of sentiment  should 
not be disregarded;  it may exert  an influence  even  at times  when  sentiment 
does not change  (for instance,  in the second  half of 1970). 
5. Hymans  speaks  of the stock market  "as a possible  source  of changes 
in consumer  sentiment"  (p. 173).  However,  studies  on the reasons  why the 
index has changed,  carried  out primarily  in 1962  and in 1969-70,  do not 
support  Hymans'  opinion.5  Most Americans  know what is happening  in 
the stock  market  only  when  very  great  changes  in stock  prices  are  occurring. 
Even at times  of major  stock  movements,  relatively  few people-and even 
relatively few stockholders-explained  their opinions about economic 
trends  by stock market  movements,  and the majority  said that events in 
the market  were  unrelated  to the course  of the economy. 
6. Studies  have been carried  out over the past ten years  to extend  the 
forecasting  horizon  of psychological  variables.  First, principles  have been 
developed  on the habituation  to news. Good as well as bad news has a 
much greater  impact  when  it first  arises  than when  it continues.  Inflation, 
for instance,  influenced  consumers  more  in 1969  than  in 1970  and  may add 
still less to consumer  apprehension  in 1971.  Second,  data have been col- 
lected on longer-run  expectations  and aspirations.  They remained  opti- 
mistic  in 1969  and 1970,  when  short-run  expectations  deteriorated  sharply.6 
From these considerations  and findings  about an absence  of consumer 
saturation,  in the fall of 1970  the Survey  Research  Center  concluded  that 
consumers'  willingness  to buy and automobile  demand  would improve 
during  the second  half of 1971. 
Third,  studies  of the origin  of changes  in consumer  sentiment  often  per- 
mit conditional  longer-run  forecasts.  For instance,  in 1970  it was found 
that apprehension  about the social problems  of the day-racial conflict, 
inner-city  problems  and poverty,  violence  and riots, as well as pollution- 
contributed  to a low level of willingness  to buy. If one assumes  that these 
problems  will remain  with us in 1971-72,  it is possible  to conclude  that in 
those  years  a return  of the  index  to its high  level  of, say, 1965  is improbable. 
5. See 1962 Survey of  Consumer  Finances, Chap. 11; 1969 Survey of  Consumer 
Finances,  Chap. 13; and the forthcoming  volume, 1970 Survey  of Consumer  Finances. 
6. On habituation  see Katona, Mass Consumption  Society, Chap. 17, and on longer- 
range  expectations,  1967 Survey  of Consumer  Finances,  Chap. 8, and especially  Katona 
and others, Aspirations  and Affluence. George  Katona  239 
But  even  if the studies  leading  to longer-range  forecasting  are  neglected, 
Hymans'  judgment  that one or two quarters  "may  be the practical  limit 
to the usefulness  of the sentiment  index"  (p. 205) is of doubtful  validity. 
Especially  in crucial  periods  of downturn  longer  lead  times  were  observed: 
As mentioned  above,  the recession  of early  1970  was  indicated  in the spring 
of 1969; similarly,  in 1957  the lead time of the index over the decline  in 
auto buying  was three  to four quarters.  In any case, continuous  surveys, 
conducted  preferably  at more frequent  intervals  than every quarter,  are 
needed to test the length of lead time, which may vary under different 
conditions. 
The longer-range  the forecast  the greater  the risk, because  something 
new and unexpected  may happen  during  the period  for which  the forecast 
is made.  This  is true  of all forecasting  methods,  but psychological  forecast- 
ing has an advantage.  It is often possible  to indicate  in advance  how con- 
sumers  would  react  to unexpected  developments.  (For instance,  in 1969-70 
consumers'  potential  reactions  to peace  in Vietnam  were  predicted  on the 
basis of extensive  studies  of attitudes.) 
The essence  of these remarks  is that the index of consumer  sentiment, 
and its forecasting  value,  should  be appraised  within  the framework  of an 
evaluation  of behavioral  economics.  The time has come  to disregard  some 
traditional  distinctions  between  endogenous  and exogenous  factors and 
to make  less use of the ceteris  paribus  clause  in economic  analysis.  Changes 
in economic  attitudes  and expectations,  which are measurable,  belong in 
the body of economics.  Hymans'  distinction  between  predictable  and un- 
predictable  (for  instance,  psychological)  components  of measures  of willing- 
ness to buy (p. 177)  represents  an attempt  to exclude  psychological  con- 
siderations  from economics and thus to turn the clock back. Juster's 
statement  that "the  sentiment  index  really  stands  for uncertainty"  (p. 201) 
contradicts  the theory  of intervening  variables  from which the index has 
evolved.7 
Behavioral  economics  is a young discipline  that must advance  substan- 
tially in order  to fulfill  its promise  to broaden  the range  of economic  in- 
quiry. By considering  the human  element  in economic  affairs,  I believe, 
it will be possible  to shed  light on a variety  of social  problems  and also to 
improve  our forecasting  tools. 
7. In addition, why should Juster's  statement  that "uncertainty  is either narrowing 
or broadening"  (p. 201)  be preferable  to a statement  that either  optimism  and confidence 
or pessimism  and malaise  are spreading? 

Consumer Durable Spending

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Consumer Durable Spending

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