When teaching A level economics, we often need to look for evaluation of a question. In macro economics one of the most effective strategies is to consider the impact of consumer confidence and expectations.
For example, suppose you have a question about the impact of a rise in VAT to 17.5%. The simple analysis is to say that the higher rate of tax will reduce consumer disposable income leading to a fall in consumer spending and economic growth.
However, the impact of a tax rise does depend on other factors.
UK Consumer Expectations
At the start of 2009, consumer expectations was at a record low. An index of 60 implies more people are negative about future economic expectations. With such a negative outlook for the economy, a tax rise would have led to a big fall in consumer spending.
In that period, interest rates were cut to 0%, but even these interest rates cuts did little to improve spending – because many consumers were pessimistic about the future so they were saving any increase in disposable income. Therefore interest rate cuts were largely ineffective.
However, if you increased taxes when consumer expectations were very positive, the impact of a tax rise may have less impact. If consumers are confident about the future, they may reduce their saving rates and borrow more rather than reduce their spending.
Many ask why the government can increase the money supply and not create inflation. In usual circumstances an increase in the money supply of £2o0bn would be inflationary. But, these are not usual circumstances, banks are unwilling to lend, consumers are not keen to borrow. Therefore, the increased money supply is not increasing inflationary pressure at the present time. In other circumstances they would
Economics is never straight forward. The impact of a policy can be very different in different circumstances. We always need to take into account other variables such as consumer expectations.
Note: Consumer Confidence index is compiled from 5 questions about current and future state of economy. The consumer expectations just asks about outlook for 6 months ahead. This shows people are expecting economy to be better in 6 months.
Past Exam Question for those interested: Discuss the idea that an economy can think itself into a recession?