Consumer confidence is the outlook that consumers have towards the economy and their own personal finance situation. This outlook can be optimistic (high consumer confidence) or pessimistic (low consumer confidence)
The level of consumer confidence will be an important factor that determines the willingness of consumers to spend, borrow and save. A high level of consumer confidence will encourage a higher marginal propensity to consumer. A fall in levels of consumer confidence is often an indicator of an economic downturn.
Factors that affect consumer confidence
- House prices – A form of wealth useful for re-mortgaging. Falling prices reduce wealth and confidence
- Economic news – Depressing statistics about global and national economy will reduce confidence and encourage saving.
- Uncertainty – a major political / economic change can lead to uncertainty which reduces confidence. For example, major terrorist attack, referendum.
- Unemployment – The fear of rising unemployment will discourage consumers.
- Inflation and real wages. High inflation will reduce confidence. Stagnant wages will make people pessimistic
- Economic growth – A recession will invariably be associated with a fall in consumer confidence; positive economic growth tends to improve consumer confidence.
- Expectations are largely based on the current economic situation and reported news. News of job losses and falling house prices are amongst the key factors which influence consumer confidence.
Measuring consumer confidence
Consumer confidence is based on qualitative surveys, where people carrying out research ask a sample of the population questions, such as:
- Do you feel confident about the general economic situation for next year?
- Do you feel confident about your personal economic situation for next year?
- Expectations regarding employment conditions six months hence
- Expectations regarding their total family income six months hence
- Confidence index are often measured in terms of +/-. With a + of 10 meaning there are greater number of people optimistic than pessimistic about the future.
OECD consumer confidence
UK Consumer confidence
GFK Consumer confidence barometer
source: GFK Consumer Confidence Barometer | 30 November 2012
Unsurprisingly after the 2008 credit crunch, consumer confidence plunged to a record low of – 38. The partial economic recovery of 2010 saw an improvement in confidence, before a second double dip led to a decline in confidence during 2011 and 2012.
There is a sharp correlation between consumer confidence and economic growth.
Long term UK consumer confidence
Source: ONS – National income accounts. UK consumer confidence since 1992.
(It shows we are a pessimistic lot. Confidence was barely positive – even in the long period of economic expansion of the late 1990s and early 2000s.)
Importance of consumer confidence
- Consumer spending is a major component of aggregate demand (60%) and economic growth. If confidence falls, this will tend to cause lower spending and reduce the rate of economic growth.
- Consumer confidence is a leading indicator. Consumer confidence can give a good indication of future economic downturns. For example, in 2008, real GDP stats took time before they indicated the economic situation, but the fall in confidence was a very good predictor of the sharp recession. See: How do we know we are in a recession?
- Confidence can become self-fulfilling. If confidence falls because of uncertainty, this can have a significant impact on other economic variables and become self-fulfilling, i.e. if confidence and spending falls, firms will react by delaying investment too.
- Consumer confidence can influence the effectiveness of economic policy. Suppose the Bank of England cut interest rates from 5% to 0.5% – in theory this gives consumers more disposable income to spend. However, if consumer confidence is very low, they are much more likely to save this extra income. Therefore, the interest rate cut may be ineffective in boosting spending. This is what happened in 2009. On the other hand, if consumer confidence is very high, consumer spending is likely to rise despite higher rates.
- In theory, it is possible for consumers to ‘talk themselves into a recession’. If people expect a recession, confidence drops, spending drops, creating a negative multiplier effect of lower growth and higher unemployment. This in turn causes more falls in consumer spending. Though in reality, consumers don’t expect a recession without some good reason. Recessions have more causes than an unexplained fall in confidence. However, the drop in confidence strengthens the underlying negative factors.
Evaluation of consumer confidence
- Consumer confidence is only a survey and people may become pessimistic for reasons not related to a change in economic fundamentals.
- Sometimes confidence can be influenced by non-economic factors and prove temporary, e.g. a major sporting success may improve confidence, but this could be very short lived.
- Falls in confidence may not be as important as the changing factors behind them. In 2008, we see a sharp fall in confidence because of the financial crisis. But, some may argue it was this financial crisis and decline in bank lending which was a more important factor in causing recession. In other words, falling confidence is a symptom rather than cause of recession.
- A fall in consumer confidence can lead to a rise in savings. When confidence returns, consumers may spend these savings on items they have delayed buying.
- Delayed investment. Similarly a decline in confidence may cause firms to hold back on investment. But, in the future this could lead to a mini boom in investment as all the delayed investment comes back into the economy.
Consumer confidence and saving rates
There is an inverse relationship between saving rates and consumer confidence. When confidence falls the immediate reaction is for households to increase savings and reduce borrowing. This makes sense if you fear unemployment, it is not the time to engage on a borrowing spree.
The sharp fall in consumer confidence of 2008, led to a sharp rise in savings ratio.