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Tuesday, December 02, 2008

Consumer confidence just a “lagging indicator”?

One thing that’s always bugged me is the way some economic writers – and I assume economists – confidently define “consumer confidence” as a “lagging indicator” – one that, to quote a business weekly writer, “responds only after the overall economy has already changed.” (Citation or link unimportant here.) Yet we see another description of “consumer confidence” like this in the same short article: “If consumers are uncertain about the economy, they will buy less and the economy will slow further. If consumer confidence increases, then the economy will grow.” This is a common formulation.

There is a fundamental reasoning problem in those two statements, however: on the one hand, we are saying that it is confidence that is the engine of the economy, and then we turn around and say that engine will only get started if the economy magically on its own improves. If we assume that an economic transaction does not occur unless both parties have confidence that it will be advantageous to them, and that an economy starts to grow when more people have the confidence to enter into transactions than had the day before, then by definition, while what we have known since 1985 as the “Consumer Confidence Index” from the Conference Board, or since 1954 as the “Index of Consumer Sentiment” from the University of Michigan may have statistically shaken out as an indicator that is discernible after the fact, confidence of some kind must be a leading indicator as well.

What we then have to assume is that the “confidence” that is the engine of an economy is a far more complex concept than the random-sample periodic surveys can capture. Indeed, something outside the economy itself – yeah, those “exogenous variables,” the terminology in the English language that perhaps more than any other makes one sound brilliant – must be the spark that starts the necessary complex of confidence in the right direction to speed up the aggregate of economic transactions. That would be things like the stimuli the United States Government can decide on its own initiative to employ to get people more money and especially more jobs.

Yes, the quantifiable mechanics of the multiplier effect will rev up the economy, but what if there is no confidence it can be sustained? Look at what has happened to recent rounds of interest rate cuts, or the tax rebate checks. Anything at all besides theoretically preventing things from getting worse? Somehow, the clear signal must accompany the stimuli: this will work, and this is not a one-shot desperation heave, but will be maintained until it works. And when it works, we will be able to start minimizing any problems we inevitably created – increasing the deficit and the national debt – the way Clinton did it in the 90s. And by the way, we know what we are doing.

Get those messages across, and confidence will build for a sustained recovery. But if you only look at “consumer confidence” as a “lagging indictor,” you may miss the central necessity of those messages.

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