June 8, 2002
Doubts on Economic Index Create Doubts on Recovery
onsumer confidence has been a mainstay of economic forecasting for more than 25 years. Alan Greenspan invokes it as a source of strength for the struggling economy. Wall Street traders buy or sell on each squiggle in the consumer confidence indexes. Politicians, economists, corporate executives, journalists all count on it to make the recovery work.
But now a growing number of researchers and economists say that consumer confidence may be a phantom concept, an attempt to quantify a state of mind that does not exist. The much-watched indexes may not capture mood swings that lead to more or less spending, they argue, but only such down-to-earth concerns as how much the next pay check will be and whether it will still be arriving six months from now.
"The fact is there is just sheer randomness in consumer spending," said Sydney Ludvigson, a New York University economist and the co-author of one of the critical studies. "No index or statistic is the silver bullet that anticipates consumption."
For those hoping for a quick economic recovery, that is disconcerting. The nation's two main consumer confidence indexes have been rising lately, encouraging many on Wall Street and in Washington to believe that optimistic consumers will revive the economy, even though actual consumer spending has been wavering. The surveys on which these indexes are based ask questions that are supposed to capture willingness to spend. In a nation that runs on consumer spending, that is a claim that has elevated the indexes to the reputation of major tools in forecasting the rise and fall of the economy.
Richard T. Curtin, the director of the University of Michigan's Survey of Consumer Sentiment, the granddaddy of the nation's two established monthly consumer confidence indexes, maintains that his index "foretells swings in the economy." Still, even he conceded that "if you want to really predict consumption, you would be better off using the details in the survey rather than the overall measure."
There is more information, Mr. Curtin said, in the answers from a cross section of the population to individual survey questions about income, unemployment, interest rates, inflation and plans to buy cars, homes, appliances and the like.
Complicating matters, American spending patterns are much more varied now than they were in the early years after World War II, when the first consumer confidence index was born at Michigan. That early index assumed the existence of a typical, average consumer, one whose mood and propensity to spend could be fathomed in a survey. That typical consumer was more likely to have existed in the 40's than today, Mr. Curtin said. "People were more focused on their jobs and wages."
Today all sorts of other factors figure into spending and interfere with consumer confidence as a national concept. Some people base their spending decisions on their wages, while others are governed by job security or the value of their stock portfolios and homes, or interest rate fluctuations, or their willingness to accumulate debt, particularly through credit cards, which did not exist in the 1940's.
And there is income inequality, which has increased since the 1970's and has affected the consumer confidence surveys, says Nicholas S. Souleles, an economist at the Wharton School of Business. Analyzing the Michigan survey data over 20 years, he found that low-income households constantly and optimistically overestimated their future incomes, while upper-income people swung from optimism in expansions to pessimism in downturns.
"You really have to look at individual households," Mr. Souleles said, "and not at some representative, average consumer. That no longer works."
Rather than concern themselves with the composite index, companies that use the surveys in their marketing efforts do focus mainly on the answers to individual questions. The overall index was an afterthought, a single number first published in 1952, six years after the surveys began. (The other major index is compiled by the Conference Board, a research group supported by companies.) The surveys were the brainchild of George Katonah, a Hungarian-born economist and psychologist who conceived of consumer confidence and organized the surveys at Michigan in the late 1940's, the goal being to capture the shifting optimism and uncertainty that in his view governed consumer spending.
Mr. Katonah, who died in 1980, also thought up the first overall index, by averaging the answers to several questions. Embracing the Katonah model, the Conference Board started its index in 1967, and the two index numbers gradually became the public face of consumer confidence, a headline number that draws quick reactions from politicians, journalists and Wall Street. As a measure of their importance, the Federal Reserve gets the monthly numbers before their public release.
All this attention to the composite index makes Mr. Curtin uneasy, he says. As Mr. Katonah's student, disciple and successor, Mr. Curtin would prefer more public interest in the individual survey questions, which do help to foreshadow future home buying and auto sales, for example, and do shed light on public expectations about inflation.
"I must admit that I view the consumer confidence index as a mixed blessing," Mr. Curtin said last month during a Princeton University symposium that explored the strengths and shortcomings of the two major indexes, drawing on the research of a handful of scholars who have been delving into their accuracy and meaning in recent years. What the new research has concluded is that the consumer confidence indexes turn out to be much better at predicting ups and downs in the employment numbers than what they are supposed to predict: swings in spending.
Ken Goldstein, a Conference Board economist, still stands by the measures. People go home and watch a little television news, he said, and they also talk to neighbors and friends and they know their own situations, particularly their job situations.
"These streams of information merge, and people pick up that something is going on, that things are getting better or worse," Mr. Goldstein explained. "When we ask our survey questions, we get the direction. We are getting a kind of pure pulse beat."
Both Mr. Goldstein and Mr. Curtin say that their indexes accurately predict swings in the gross domestic product, a government measure that tracks expansions and contractions in the economy.
But Dean Croushore, an economist at the Federal Reserve Bank of Philadelphia, who is preparing yet another study of the indexes, says they often gyrate after an expansion or a recession has begun, not before. "Look at the charts," he said. "The biggest drops in the indexes are after recessions have begun."
Yet ascertaining which comes first, the economic swing or the index swing, is not as straightforward as it might seem. Researchers have been comparing the confidence indexes to data that has been updated and revised over a five-year period. Sometimes an initial report that the economy expanded in a quarter is later revised to a contraction. Consumer spending data has gone through similar revisions. Would the indexes look more omniscient if they were superimposed on initial data; that is, the information people had available to them when they were surveyed? Mr. Croushore is trying to answer this question.
Whatever the shortcomings of the consumer confidence indexes, nearly all the researchers agree that when combined with other data, they provide some additional information in forecasting consumption. "Let's suppose that we are going to forecast consumption growth without using the confidence indexes," Mr. Croushore said. "Forecasters have used past consumption, past income, past changes in interest rates and past returns to the stock market, up to the day of the forecast. Suppose we forecast with that, and then we add consumer confidence to the model. If you use both confidence indexes, then you can improve your forecast by about 13 percent for consumer spending."
That may satisfy the purists but not all those counting on consumer confidence for a recovery.