Hope Floats

Americans appear to be increasingly optimistic about the economy, despite threats both at home and abroad. Are they irrational, or prescient?

A shopper leaves Costco with a cart full of goods on Tuesday, March 27, 2012, in Portland, Ore. Americans are holding onto a rosier view of the U.S. economy as they focus on the good in a flood of mixed economic news. 
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Catherine Hollander
Sept. 27, 2012, noon

This fall, eco­nom­ic doom and gloom would seem to be lurk­ing just around the corner.

It’s em­bod­ied in fears of fal­lout from the euro­zone sov­er­eign-debt crisis spread­ing across the At­lantic and the pos­sib­il­ity that U.S. law­makers might not strike a deal dur­ing the lame-duck ses­sion of Con­gress to pre­vent the coun­try from fa­cing an ab­rupt com­bin­a­tion of tax hikes and spend­ing cuts, the so-called fisc­al cliff.

In terms of the eco­nomy’s per­form­ance, the story of the last few months isn’t great, either. Payroll growth has av­er­aged few­er than 100,000 jobs — roughly the amount needed to simply keep pace with pop­u­la­tion growth — for the past five months. The Fed­er­al Re­serve Board is so wor­ried about the an­em­ic jobs mar­ket that it em­barked on a con­tro­ver­sial new round of bond-buy­ing earli­er this month.

Yet des­pite the lackluster em­ploy­ment pic­ture and the risk of a big hit to growth from ex­pir­ing tax cuts and auto­mat­ic spend­ing cuts, con­sumers are feel­ing more op­tim­ist­ic. Just this week, the Con­fer­ence Board’s Con­sumer Con­fid­ence In­dex hit a sev­en-month high. A pre­lim­in­ary read­ing of the Thom­son Re­u­ters/Uni­versity of Michigan In­dex of Con­sumer Sen­ti­ment for Septem­ber shows it climb­ing to its highest level in four months. After plunging last sum­mer amid the debt-lim­it stan­doff, the trend for con­fid­ence has been up­ward and on­ward. Why?

Ross De­Vol, chief re­search of­ficer at the Santa Mon­ica, Cal­if.-based Milken In­sti­tute, has a simple an­swer: stock prices. They are the single most im­port­ant factor for month-to-month changes in con­fid­ence. Re­cent signs that the hous­ing mar­ket has sta­bil­ized also play a key role, as homes are a ma­jor source of house­hold wealth.

“This is kind of the “˜wealth ef­fect’ on con­sumer con­fid­ence, and I think is the prin­cip­al reas­on why con­fid­ence has re­boun­ded more than you might think in the middle of a euro­zone crisis and all the un­cer­tainty sur­round­ing that, the do­mest­ic fisc­al cliff,” De­Vol said.

As of this writ­ing, the S&P 500 is up more than 25 per­cent from last Septem­ber. By in­ject­ing cash in­to the eco­nomy, the Fed’s bond-buy­ing has helped drive up stock prices, boost­ing the con­fid­ence num­bers. “There’s more li­quid­ity in the mar­ket, and equity mar­kets love that,” De­Vol said.

Amna Asaf, a Toronto-based eco­nom­ist at Cap­it­al Eco­nom­ics, cites gas­ol­ine as well as equity prices as cru­cial de­term­in­ants of con­fid­ence. As equity prices have climbed, gas prices have been re­l­at­ively stable over the past year, rising just 6 per­cent on a sea­son­ally ad­jus­ted basis, Asaf says, help­ing to ac­count for the rise in con­fid­ence.

Al­though Wash­ing­ton is trans­fixed by the loom­ing fisc­al cliff and the fear that the eco­nomy will plunge over the edge, few Amer­ic­ans are pay­ing at­ten­tion to that right now. The im­pact on con­sumer psy­cho­logy prob­ably won’t show up un­til Novem­ber and Decem­ber, after the elec­tion gives way to a dis­cus­sion about the coun­try’s fisc­al fu­ture. “My guess is, we’re go­ing to have to get a lot closer and it’s go­ing to have to look a lot more omin­ous,” said Dean Baker, co­dir­ect­or of the Cen­ter for Eco­nom­ic and Policy Re­search.

CEOs, who are already factor­ing the im­pend­ing — and sure to be ugly — tax de­bate in­to their fore­casts, were much more pess­im­ist­ic about the fu­ture. The Busi­ness Roundtable’s third-quarter CEO Eco­nom­ic Out­look Sur­vey, re­leased this week, de­clined from 89.1 in the second quarter to 66.0 in the third. The down­shift, ac­cord­ing to Roundtable Chair­man Jim McNer­ney, partly re­flects un­cer­tainty sur­round­ing the fisc­al cliff. Con­sumers, who aren’t yet pon­der­ing taxmaggedon, have high­er hopes for the fu­ture: The Con­fer­ence Board’s ex­pect­a­tions in­dex climbed from 71.1 in Au­gust to 83.7 in Septem­ber.

Eco­nom­ists track the con­fid­ence num­bers, and the ex­pect­a­tions in­dex in par­tic­u­lar, for signs of wheth­er con­sumers are likely to open their wal­lets and help power the eco­nomy or stash their money away. Where they dis­agree is how ac­cur­ate those num­bers are as gauges of fu­ture spend­ing.  

Marta Lachow­ska, an eco­nom­ist at the W.E. Up­john In­sti­tute for Em­ploy­ment Re­search in Kala­ma­zoo, Mich., wrote a pa­per last sum­mer ask­ing, “What Do In­dexes of Con­sumer Con­fid­ence Tell Us?” She con­cluded that con­fid­ence likely does fore­cast changes in con­sumer spend­ing by bring­ing to­geth­er in­form­a­tion that mat­ters to con­sumers but isn’t in­de­pend­ently ob­serv­able by eco­nom­ists.

De­Vol says he has seen the pre­dict­ive power of the in­dexes de­cline over time. Quirks in how the sur­veys are put to­geth­er have caused them to weight middle- and lower-in­come house­holds more heav­ily in pro­por­tion to the broad­er pop­u­la­tion. But he still finds it use­ful to look at con­sumer re­sponses to ques­tions about wheth­er they will buy big-tick­et items such as cars and ap­pli­ances. “I think those are bet­ter in­dic­at­ors of what con­sumers are go­ing to do than over­all weight­ing all the vari­ous factors,” he said.

CE­PR’s Baker, however, says that the gauges are more use­ful as a snap­shot of at­ti­tudes today than what will hap­pen next month. Both the Con­fer­ence Board and the Thom­son Re­u­ters/Uni­versity of Michigan in­dexes have three com­pon­ents: a head­line com­pos­ite num­ber — the one that the press fo­cuses on each month — and meas­ures of con­sumer at­ti­tudes about cur­rent eco­nom­ic con­di­tions as well as their fu­ture ex­pect­a­tions.

“Cur­rent con­di­tions tend to be [a] reas­on­ably good … in­dic­at­or of what’s go­ing on today,” Baker said. Fu­ture ex­pect­a­tions, on the oth­er hand, are more volat­ile, even though ac­tu­al con­sump­tion tends to be stable, sug­gest­ing that the meas­ures of ex­pect­a­tions are not the best gauge of what’s to come, he said.

Today, the Con­fer­ence Board’s com­pos­ite con­fid­ence read­ing is 70.3, well be­low 90, the level as­so­ci­ated with a healthy eco­nomy. And it’s far be­low 111.9, the peak reached in the sum­mer of 2007. With threats loom­ing at home and abroad, that sky-high level of ex­uber­ance isn’t likely to re­turn any­time soon.