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Economic News, Data and Analysis

Confidence Games

It ain’t that
bad?

As the recession
talk continues, another piece of “bad news” came out recently — from a
press
release
dated February 27, 2001:

“The
Conference Board’s Consumer Confidence Index fell in February for the fifth
consecutive month. The Index now stands at 106.8 (1985=100), down from
115.7 in January.”

Alan Greenspan referred
to this news in testimony to Congress on February 28th:

“Changes
in consumer confidence will require close scrutiny in the period ahead,
especially after the steep falloff of recent months,” 

The press release
also stated that “Consumer Confidence has not been this low since June
1996, when it was 100.1.”

Gasp! Not 1996!
I’m sure you remember the horror of the economy in 1996 – unemployment
relatively low and falling, economic growth solid, five years into an expansion
with few signs of slowing (and as it turned out, with 5 years of good growth
to come). 

Yes, confidence
(as measured by this index) has fallen steeply in the past few months,
and we should keep an eye out for further declines, but we’re not yet near
the levels seen in recessionary periods, when the index has fallen to the
50-70 range.

Measuring confidence

The measure of
consumer confidence most often cited is the Conference Board’s Consumer
Confidence Index. The index is based on a survey of 5,000 households and
asks questions concerning business conditions, employment prospects, and
income expectations. Of course, collapsing the answers to several questions
by thousands of people into a single number is fraught with difficulties;
however, movement in one direction or the other has mirrored economic outcomes
in the past. (See graph).

Self-fulfilling
prophecy?

Does consumer
confidence drive the economy, or is it the other way around? The answer
is – both. Greater confidence leads to stronger spending and hence a stronger
economy (at least in the short run). However, the causality works the other
way as well – a strong economy causes a high degree of confidence. 

Unfortunately,
the confidence game works in the downward direction as well. Less confidence
-> weak economy -> even less confidence. Once started, this is a recipe
for a downward spiral and why it has been rare for policymakers to make
negative comments about the economy. Even though the comments may be correct,
this feedback cycle can amplify and initial weakness.

Oil? Interest
Rates?…

If we are indeed
headed into a slowdown (which is still not certain), we might want to ask
what was the cause. Two leading explanations are (1) the recent rise
in energy prices
, and (2) the interest rate hikes by the Federal Reserve
which came midway through 2000. 

Representative
Barney Frank pressed Greenspan on this second issue during the House
testimony
:

“Based
on your own rules of thumb, the actions the Federal Reserve System took
[last year] clearly contributed to the slowdown.”

… or
Animal Sprits?

Maybe it’s in
our nature to shake things up.

“Even
apart from the instability due to speculation, there is the instability
due to the characteristic of human nature that a large proportion of our
positive activities depend on spontaneous optimism rather than mathematical
expectations, whether moral or hedonistic or economic. Most, probably,
of our decisions to do something positive, the full consequences of which
will be drawn out over many days to come, can only be taken as the result
of animal spirits – a spontaneous urge to action rather than inaction,
and not as the outcome of a weighted average of quantitative benefits multiplied
by quantitative probabilities.” — J.M. Keynes

One wonders what
Keynes would have thought about animal spirits in the current age of information
and media frenzy, when our “spontaneous urge to action rather than inaction”
is surveyed, broadcast, and reflected back to us in record time.

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