Consumer Confidence and Spending Behavior

Elsewhere on this web site, we defined consumer confidence in Latin America in the Los Medios y Mercados de Latinoamérica study. We also showed how data trending demonstrated the sensitivity of these measures to existing economic conditions through cross-sectional time series. In this paper, we wish to show how consumer confidence relates to spending behavior.

Consumer spending can be classified into necessary and discretionary expenditures. No matter what, people are expected to come up with their basic daily necessities, such as food, clothing and shelter. These necessary expenditures tend to be relatively stable over time, and do not fluctuate radically. Even so, in hard times, consumers may use cheaper substitutes. For example, when beef becomes too expensive, chicken may be used instead.

Discretionary expenditures are much more sensitive to changes in economic conditions. Such expenditures include the purchase of expensive items such as durables (refrigerators, television sets, etc), automobiles or even houses. Some of these items are quite expensive and can sometimes only be paid for by taking out long-term loans which are expected to be repaid from the future earnings stream. The desirability of these expenditures clearly depends on a number of objective factors, including

• riskiness of the future earnings stream
• employment prospects and opportunities
• interest rates
• inflation rates
• product prices and values

But no matter what the objective conditions actually are, the subjective opinions and expectations of consumers are just as important. After all, most consumers probably regard pronouncements about the state of the economy with a great deal of skepticism and place greater weight on their own personal circumstances.

When consumers are pessimistic, they will postpone their discretionary expenditures. In turn, the drop in consumer demand leads to a contraction of the economy. Conversely, when consumers are optimistic, they will make their discretionary expenditures. In turn, the surge in consumer demand leads to economic growth.

Well, enough with theory already. In Table 1 below, we show how optimistic and pessimistic consumers actually fare with respect to purchasing a number of different consumer durable items. For example, 10.3% of those who said they were financially better off now than 12 months ago actually went and bought a new refrigerator; whereas only 3.1% of those who said that they were financially worse off now than 12 months ago did so. In each case, we observe that the optimistic consumers are more likely to make purchases during that time period.

An important lesson that can be drawn is that consumer confidence can have a major impact on the state of the economy. Macroeconomic intervention by the government are effective only to the extent that they affect consumer behavior, although sometimes the best intentions can have perverse effects due to unanticipated attitudinal perceptions.

Table 1.
% of people who purchased products by those who felt better off
and those who felt worse off financially than 12 months ago.

(source: Los Medios y Mercados de Latinoamérica 1996)

In the above discussion, we have used the retrospective measure of consumer confidence for which we have historical purchase information. The prospective measure of consumer confidence (with respect to the next 12 months) can be used to forecast the direction of the economy, although we obviously do not have any means of validating it.

(posted by Roland Soong, October 6th, 1997)

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