Consumer behavior ; Consumption (Economics)

Adrian W. Throop

English

Research Papers in Economics

FRBSF WEEKLY LETTER
Number 91-26, July 19, 1991
Consumer Confidence
and the Outiook for
Consumer Spending
Current Conditions
40 +--rr-r-,---,r-r-""";---r-,.--,r-r--.--r-r--.--,...,+ 40
Jan Apr Jul Oct Jan Apr
1990 1991
spending on durables may be affected by per-
ceived uncertainty because cutting back on
purchases of durables is a relatively low cost
way of adjusting to the likelihood of a future
shortfall of income.
80
60
r120
100
Business Cycle Peak
I
Michigan
Survey
................... Conference r····.
Board:
Indexes of Consumer Confidence
Expected Conditions
80
60
Both surveys of consumer confidence have a
set of questions relating to household percep-
tions of current economic conditions. The Michi-
gan survey asks whether the household is now
financially better off than it was a year ago and
1201
100
140 Business Cycle Peak 140
120 120
100 100 Michigan
80 Survey 80
60 Conferen~e"'" 60
Board •...........
40 +--rr-r-,---,r-r-""";r-r-,---,r-r-,.--,r-r--,--,--.+ 40
Jan Apr Jul Oct Jan Apr
1990 1991
This Weekly Letter discusses the differences
between the Michigan and Conference Board
surveys of consumer confidence as well as the
track record of these two surveys, and their com-
ponents, in predicting subsequent consumer
expenditures on consumer durables. The results
of the analysis are then used to evaluate the
outlook for consumer spending.
What the surveys ask
Surveys of consumer confidence have been
found to be helpful in predicting expenditures
on consumer durables. The most important thing
that these surveys appear to measure is house-
hold perceptions of uncertainty or risk associated
with the likelihood of job loss, severe income
loss, and attendant financial distress. Household
The economic recession has been widely
attributed to a collapse of consumer confidence
beginning in August of last year, following Iraq's
invasion of Kuwait. A recovery in confidence
therefore could spur consumer spending and the
economic recovery. After hitting bottom between
October and January, both the Michigan and
Conference board indexes of consumer confi-
dence moved up sharply in March, and then
receded somewhat in the next two months.
Although both indexes point to a recovery, their
underlying components are giving off confiicting
signals. The "expected conditions" component
of each index has risen sharply since January. But
the "current conditions" component of the Con-
ference Board Survey has continued to fall, while
a similar component of the Michigan survey has
risen relatively little. (See the accompanying
chart.) Depending on the importance of these
various components of confidence for predicting
consumer behavior, we could soon see expendi-
tures on consumer durables either rise sharply,
signaling a recovery, or even fall, implying that
the recession is dragging on.FRBSF
whether now is a good time to buy a major
household item. In contrast, the Conference
Board survey asks for appraisals of current busi-
ness conditions and current employment condi-
tions. Thus, the 'current conditions componentof
the Michigan survey tends to focus more directly
on the risk of near-term financial distress and its
implications for current purchases of consumer
durables.
Both surveys also contain a set of questions on
expectations of future economic conditions. The
Michigan survey asks whether households expect
to be better off financially a year from now and
what the prospects for the economy are likely to
be both one year and five years in the future. The
Conference Board survey focuses on nearer-term
expectations, asking about expected business
conditions and household employment and
income six months hence.
Do surveys help in forecasting?
The predictive po\ver of the t\lv'O surveys vvas
tested within the context of a stock-adjustment
model of consumer expenditures on durables.
In this framework, consumers purchase durables
as they adjust the actual stock of durables to their
desired levels. The desired stock of consumer du-
rabies depends on the level of total consumption
and the cost of capital.
Importantly, the cost of capital depends not only
on the level of interest rates and the physical rate
of depreciation ofdurables, but also on uncer-
tainty about future income. More uncertainty
about future income increases the likelihood that
consumers would have to sell durables in order
to raise cash at a time of future financial distress.
But since consumer durables are illiquid, a seller
would receive less than their full value under
such circumstances. Because of this loss to the
seller a greater likelihood of financial distress
increases the effective cost of capital for con-
sumer durables. To the extent that surveys of
consumer confidence measure the uncertainty
and risk perceived by households, they therefore
help to determine the desired stock of durables,
and hence current purchases.
To evaluate the usefulness ofthese surveys,
this model of consumer expenditures on durables
was first estimated for the period 1971.Q1 through
1979.Q4. The model then was used to make an
"out of sample" forecast of spending on con-
sumer durables for the four-quarter period from
1979.Q4 through 1980.Q4, with and without the
inclusion of survey measures of consumer confi-
dence, or their components. ~~ext, the param-
eters of the model were reestimated using data
from the initial sample plus the four quarters just
forecast, and a new four-quarter ahead forecast
was made for the period from 1980.Q4 through
1981.Q4. These steps were then repeated to gen-
erate a sample of four-quarter ahead forecasts
for the entire 1979.Q4 to 1990.Q4 period.
For the Michigan survey, the results suggest that
the "current conditions" component contains all
of the useful information for forecasting expendi-
tures on consumer durables. Including only the
current conditions component in the model re-
duced the (root-mean-squared) forecasting error
substantially-by over Y2-from what it would
be without using any measure of confidence;
using the overall index, which includes both
components, reduced the forecasting error by
much less-only about Ys. Thus, the expecta-
tions component of the Michigan survey contains
no useful information for forecasting expenditures
on consumer durables, and indeed reduces the
accuracy of forecasts. (This component is of
value, however, in predicting expenditures on
housing where longer-term decisions are
involved.)
Given the importance of the current conditions
component of the Michigan survey, it is signifi-
cant that by May this component stood above
its February lowpoint. For this indicates that an
upswing in confidence should contribute to the
growth of spending on consumer durables.
About half of the total estimated effect of this
measure of confidence on spending occurs
contemporaneously and with a one-quarter lag,
while the remainder happens over the next five
quarters. At the same time, however, the current
conditions component of the Michigan index
cautions us not to expect a strong rebound. In
May, this component had recovered only Y4 of
the decline that began in August, versus about
Y2 for the overall index.
The performance of the Conference Board's
survey is similar to the Michigan survey, though
much weaker. Using only the current conditions
component reduced forecasting errors by a third,while including the overall measure of consumer
confidence in the model reduced forecasting
errors by only Via.
As with the Michigan survey, then, the current
conditions component contains all of the useful
information for forecasting expenditures on con-
sumer durables. However, forecasting errors us-
ing the Conference Board survey exceed those
with the Michigan survey by more than 113.
Conclusion
The results ofthis analysis indicate that the most
accurate forecasts of expenditures on consumer
durables can be obtained by including the cur-
rent conditions component of either the Con-
ference Board or University of Michigan surveys
of consumer confidence in a stock-adjustment
model of consumer purchases. At the present
time, however, this component has been moving
in opposite directions in the two surveys. The
Michigan survey is predicting a recovery in
expenditures on consumer durables, while the
Conference Board survey indicates a continued
depressive effect of consumer confidence on
purchases.
Greater weight can be put on the predictions
of the Michigan survey because of its lower fore-
casting errors over the past decade. Properly
interpreted, however, even the Michigan survey
is forecasting only a relatively modest recovery
in consume~ exp~nditures o~ durables. By Ap'ril,
the overall Michigan index had recovered over
Y2 of the decline that began last August. But over
the same period the current conditions compo-
nent ofthe Michigan index-which is the most
useful for forecasting-had regained only a quar-
ter of its earlier decline. Thus, even the Michigan
survey indicates that the consumer is not yet a
strong force for economic recovery.
Adrian W. Throop
Research Officer
Opinions expressed in this newsleiier do not necessarily refled the views of the management of the Federal Reserve Bank of
San Francisco, or of the Board of Governors of the Federal Reserve System.
Editorial comments may be addressed to the editor (Judith Goff) or to the author.... Free copies of Federal Reserve
publications can be obtained from the Public Information Department, Federal Reserve Bank of San Francisco, P.O. Box 7702,
San Francisco 94120. Phone (415) 974-2246.OUt'6 V) 'OJSPUI?J:I UI?S
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Index to Recent Issues of FRBSF Weekly Letter
DATE NUMBER TITLE AUTHOR
2/1
2/8
2/15
2/22
3/1
3/8
3/15
3/22
3/29
4/5
4/12
4/19
4/26
5/3
5/10
5/17
5/24
5/31
6/7
6/14
7/5
(91-5)
(91-6)
(91-7)
(91-8)
(91-9)
(91-10)
(91-11)
(91-12)
(91-13)
(91-14)
(91-15)
(91-16)
(91-17)
(91-18)
(91-19)
(91-20)
(91-21 )
(91-22)
(91-23)
91-24
91-25
Taiwan's Trade Surpluses
Controlling Inflation
District Agricultural Outlook
Economic Reform in China
Consumer Sentiment and the Economic Downturn
Recapitalizing the Banking System
Droughts and Water Markets
Inflation and Economic Instability in China
Banking and Commerce: The japanese Case
Probability of Recession
Depositor Discipline and Bank Runs
European Monetary Union: Costs and Benefits
Record Earnings, But..,
The Credit Crunch and The Real Bills Doctrine
Changing the $100,000 Deposit Insurance Limit
Recession and the West
Financial Constraints and Bank Credit
Ending Inflation
Using Consumption to Forecast Income
Free Trade with Mexico?
Is the Prime Rate Too High?
Moreno
Furlong/Trehan
Dean
Cheng
Throop
Pozdena
Schmidt
Cheng
Kim
Huh
Neuberger
Glick
Zimmerman
Walsh
Levonian/Cheng
Cromwell
Furlong
judd/Motley
Trehan
Moreno
Furlong
The FRBSF Weekly Letter appears on an abbreviated schedule in june, july, August, and December.

Consumer confidence and the outlook for consumer spending

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Consumer confidence and the outlook for consumer spending

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