Imagine that you are talking with your neighbor in your backyard, and
you mention that you and your wife are shopping for a new car, you are
getting ready to refinance your house and your wife’s brother recently
lost his job. Your neighbor tells you he was recently promoted, his wife
is starting a business and his daughter just bought a new computer.
What kind of analysis about the health of the U.S. economy could an
economist make based on your backyard conversation? Well, that depends
on what the conversation suggests about consumer confidence.
The mention of recent or upcoming purchases of a computer and a car
suggests strong consumer demand. Your plan to refinance your home is a
positive sign for the future, implying that you are confident in your
ability to meet future mortgage payments. The refinancing suggests also
the possibility of lower mortgage payments, which could mean an increase
in your discretionary income. Your neighbor’s promotion and the start
of his wife’s new business are also positive economic signs. The only
negative reference during the conversation was the mention of one person
who recently lost a job. But from the other information exchanged
between you and your neighbor, the economist might conclude that
consumer confidence is high. That is good news for the economy because,
on average, consumers are responsible for two-thirds of the nation’s
economic activity, or the gross domestic product (GDP).
Consumer Confidence
Consumer confidence, measured by the Consumer Confidence Index (CCI),
is defined as the degree of optimism on the state of the economy that
consumers (like you and me) are expressing through their activities of
saving and spending. The CCI is prepared by the Conference Board and was
first calculated in 1985. In that year, the result of the index was
arbitrarily set to 100, representing the index’s benchmark. This value
is adjusted monthly based on results of a household survey of consumers’
opinions on current conditions and future economic expectations.
Opinions on current conditions make up 40% of the index, with
expectations of future conditions comprising the remaining 60%.
In the glossary on its website, the Conference Board defines the
Consumer Confidence Survey as “a monthly report detailing consumer
attitudes and buying intentions, with data available by age, income and
region.” In the most simplistic terms, when their confidence is trending
up, consumers spend money, indicating a healthy economy. When
confidence is trending down, consumers are saving more than they are
spending, indicating the economy is in trouble. The idea is that the
more confident people feel about the stability of their incomes, the
more likely they are to make purchases.
The Survey
Each month the Conference Board surveys 5,000 U.S. households. The
survey consists of five questions that ask the respondents’ opinions
about the following:
- Current business conditions.
- Business conditions for the next six months.
- Current employment conditions.
- Employment conditions for the next six months.
- Total family income for the next six months. Survey participants are asked to answer each question as “positive,” “negative” or “neutral.”
The results from the Consumer Confidence Survey are released on the last Tuesday of each month at 10am EST.
The Calculations
Once the data has been gathered, a portion known as the “relative
value” is separately calculated for each question; each question’s
positive responses are divided by the sum of its positive and negative
responses. The relative value for each question is then compared against
each relative value from 1985, which is set as the benchmark because
1985 is the first year the index was calculated. This comparison of the
relative values results in an “index value” for each question.
The index values for all five questions are then averaged together to
form the Consumer Confidence Index. The average of index values for
questions one and three form the Present Situation Index; and the
average of index values for questions two, four and five form
the Expectations Index. The data is calculated for the United States as a
whole and for each of the country’s nine census regions.
How the Data is Used
Manufacturers, retailers, banks and the government monitor changes in
the CCI to factor in the data in their decision-making processes. While
index changes of less than 5% are often dismissed as inconsequential,
moves of 5% or more often indicate a change in the economy’s direction. A
month-on-month decreasing trend suggests consumers have a negative
outlook on their ability to secure and retain good jobs. Thus,
manufacturers may expect consumers to avoid retail purchases,
particularly large-ticket items that require financing. Manufacturers
may pare down inventories to reduce overhead and/or delay investing in
new projects and facilities. Likewise, banks can anticipate a decrease
in lending activity, mortgage applications and credit card use.
When faced with a down-trending index, the government has a variety
of options, such as issuing a tax rebate or taking other fiscal or
monetary action to stimulate the economy. Conversely, a rising trend in
consumer confidence indicates improvements in consumer buying patterns.
Manufacturers can increase production and hiring. Banks can expect
increased demand for credit. Builders can prepare for a rise in home
construction and government can anticipate improved tax revenues based
on the consumer spending increase.
Lagging Perspective
The next time you hear the results from the latest Consumer
Confidence Survey, keep in mind that economists view consumer confidence
as a lagging indicator, which responds only after the overall economy
has already changed. The explanation for this delayed CCI reaction is
that it takes time for consumers to recover from and respond to economic
events. The importance of a lagging indicator is that it confirms that a
pattern is occurring. So, an increase in spending today may reflect the
results of an economy that recovered a few months ago. Conversely, a
decrease in spending today may confirm an ongoing recession.
Conclusion
Since consumer spending is so important to the nation’s financial
health, the Consumer Confidence Index is one of the most accurate and
closely watched economic indicators. The index is based on a survey of
five questions posed to 5,000 households, measuring their optimism on
the economy’s health. The CCI, however, is a lagging indicator, so
whatever the survey says, remember that it doesn’t tell us what is going
to happen, but what has happened and if it can be expected to continue.
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