Imagine that you are talking with your neighbor in your backyard, and you mention you and your wife are shopping for a new car, you are getting ready to refinance your house and your wife's brother recently lost his job. Your neighbor tells you he was recently promoted, his wife is starting a business and his daughter just bought a new computer. What kind of analysis about the health of the U.S. economy could an economist make based on your backyard conversation? Well, that depends on what the conversation suggests about consumer confidence.
The mention of recent or upcoming purchases of a computer and a car suggests strong consumer demand. Your plan to refinance your home is a positive sign for the future, implying you are confident in your ability to meet future mortgage payments. The refinancing suggests also the possibility of lower mortgage payments, which could mean an increase in your discretionary income. Your neighbor's promotion and the start of his wife's new business are also positive economic signs. The only negative reference during the conversation was the mention of one person who recently lost a job. But from the other information exchanged between you and your neighbor, the economist might conclude consumer confidence is high. That is good news for the economy because, on average, consumers are responsible for two-thirds of the nation's economic activity, or the gross domestic product (GDP).
Measuring Consumer Confidence
Consumer confidence, measured by the Consumer Confidence Index (CCI), is defined as the degree of optimism about the state of the economy that consumers (like you and me) are expressing through their activities of saving and spending. The CCI is prepared by the Conference Board and was first calculated and benchmarked in 1985. This value is adjusted monthly based on results of a household survey of consumers' opinions on current conditions and future economic expectations. Opinions on current conditions make up 40% of the index, with expectations of future conditions comprising the remaining 60%.
In the glossary on its website, the Conference Board defines the Consumer Confidence Survey as "a monthly report detailing consumer attitudes and buying intentions, with data available by age, income and region." In the most simplistic terms, when their confidence is trending up, consumers spend money, indicating a healthy economy. When confidence is trending down, consumers are saving more than they are spending, indicating the economy is in trouble. The idea is the more confident people feel about the stability of their incomes, the more likely they are to make purchases.
The CCI Survey
Each month the Conference Board surveys 5,000 U.S. households. The survey consists of five questions about the following:
Present Situation Index
- Respondents’ appraisal of current business conditions
- Respondents’ appraisal of current employment conditions
- Respondents’ expectations regarding business conditions six months hence
- Respondents’ expectations regarding employment conditions six months hence
- Respondents’ expectations regarding their total family income six months hence
Survey participants are asked to answer each question as "positive," "negative" or "neutral." The results from the Consumer Confidence Survey are released on the last Tuesday of each month at 10 a.m. ET. (For related reading, see: Consumer Confidence: A Killer Statistic.)
Once the data has been gathered, a portion known as the "relative value" is separately calculated for each question; each question's positive responses are divided by the sum of its positive and negative responses. The relative value for each question is then compared against each relative value from 1985, which is set as the benchmark because 1985 is the first year the index was calculated. This comparison of the relative values results in an "index value" for each question.
The index values for all five questions are then averaged together to form the Consumer Confidence Index. The average of index values for questions one and three form the Present Situation Index, and the average of index values for questions two, four and five form the Expectations Index. The data is calculated for the United States as a whole and for each of the country's nine census regions.
How the Data Is Used
Manufacturers, retailers, banks and the government monitor changes in the CCI to factor in the data in their decision-making processes. While index changes of less than 5% are often dismissed as inconsequential, moves of 5% or more often indicate a change in the economy's direction. A month-on-month decreasing trend suggests consumers have a negative outlook on their ability to secure and retain good jobs. Thus, manufacturers may expect consumers to avoid retail purchases, particularly large-ticket items that require financing. Manufacturers may pare down inventories to reduce overhead and/or delay investing in new projects and facilities. Likewise, banks can anticipate a decrease in lending activity, mortgage applications and credit card use.
When faced with a down-trending index, the government has a variety of options, such as issuing a tax rebate or taking other fiscal or monetary action to stimulate the economy. Conversely, a rising trend in consumer confidence indicates improvements in consumer buying patterns. Manufacturers can increase production and hiring. Banks can expect increased demand for credit. Builders can prepare for a rise in home construction and government can anticipate improved tax revenues based on the consumer spending increase. (For related reading, see: How Tax Cuts Stimulate the Economy.)
The next time you hear the results from the latest Consumer Confidence Survey, keep in mind some economists view consumer confidence as a lagging indicator, which responds only after the overall economy has already changed. The explanation for this delayed CCI reaction is it takes time for consumers to recover from and respond to economic events. The importance of a lagging indicator is it confirms a pattern is occurring. So, an increase in spending today may reflect the results of an economy that recovered a few months ago. Conversely, a decrease in spending today may confirm an ongoing recession.
Some economists also view the CCI as a leading indicator, since a rise or fall of the index is a strong indication of the future level of consumer spending, which accounts for 70% of the economy.
The Bottom Line
Since consumer spending is so important to the nation's financial health, the Consumer Confidence Index is one of the most accurate and closely watched economic indicators. The index is based on a survey of five questions posed to 5,000 households, measuring their optimism on the economy's health. The CCI, however, is a lagging indicator, so whatever the survey says, remember it doesn't tell us what is going to happen, but what has already happened and if it can be expected to continue. (For related reading, see: Leading Economic Indicators Predict Market Trends.)