Can Consumer Confidence Forecast Household Spending? Evidence from the European Commission Business and Consumer Surveys

Abstract

1. IntroductionThe analysis of the impact of consumer attitudes on consumer spending has been an area of sustained interest in the macroeconomics literature. This interest in consumer attitudes reflects a popular belief that macroeconomic outcomes depend heavily on consumers' expectations of future economic conditions. Reinforcing this belief is the fact that consumer spending accounts for 60% to 70% of the Gross Domestic Product of highly industrialized countries such as the G-7.During the past few decades, a number of single-country investigations have attempted to assess the predictive power of consumer confidence in forecasting household spending. For example, in the United States, Mishkin (1978) reports that the Index of Consumer Sentiment (ICS) published by the University of Michigan possesses good explanatory power for changes in durable goods. Carroll, Fuhrer, and Wilcox (1994) also find that the Michigan ICS has good predictive capability with regard to household expenditure but that its forecasting power decreases considerably when the Index is used along with other macroeconomic variables.1 Kwan and Cotsomitis (2004) examine the robustness of Carroll, Fuhrer, and Wilcox's (1994) findings when alternative measures of consumer confidence are used in their prediction equations. They report that use of the Michigan Index of Consumer Expectations improves on the estimation results of Carroll, Fuhrer, and Wilcox (1994). Bram and Ludvigson (1998) and Ludvigson (2004) compare the forecasting performance of the Michigan ICS and the U.S. Conference Board's Index of Consumer Confidence (ICC). Their findings indicate that the Conference Board's index provides additional information about future consumer consumption that is not captured by the Michigan index. However, Chopin and Darrat (2000), utilizing a multivariate causality framework, report that the Conference Board's ICC is an unreliable predictor of U.S. retail sales.As regards other studies using non-U.S. data, Acemoglu and Scott (1994) employ Granger causality and regression analyses to determine if consumer confidence, as measured by the Gallup Poll in the United Kingdom, can predict future consumption. They find that consumer confidence is a leading indicator of future consumption growth. In a subsequent study, Delorme, Kamerschen, and Voeks (2002) examine whether consumer confidence and rational expectations are the same in the United Kingdom as they are in the United States. They report that the predictive ability of the U.K consumer confidence index is greater than that of the United States. Belessiotis (1996), using French data, also reports that the consumer confidence index provides decent explanatory power for future consumer spending. In Canada, Kwan and Cotsomitis (2005) find that although consumer sentiment is a reliable predictor of consumer expenditures at the national level, results obtained using regional data are quite mixed. Fan and Wong (1998) find that, unlike the case in the United States or the United Kingdom, confidence indicators in Hong Kong have little or no explanatory power in forecasting household spending.The existing studies on the ability of consumer confidence to predict household spending have produced mixed results. The results vary, depending on the sample period chosen, the frequency of observations (monthly or quarterly), and the different survey methodologies employed to gauge consumer attitudes. Moreover, most of these studies confine their attention to single-country investigations. Given the diversity of results, it is important to investigate the predictive power of consumer confidence on the basis of comparable time series data for as many countries as possible.This paper presents a first formal attempt to study the ability of consumer confidence to forecast household spending within a multicountry framework. To this end, we use two confidence indices, namely the Consumer Confidence Indicator (CCI) and the Economic Sentiment Indicator (ESI), both of which are derived from the European Commission Business and Consumer Survey (ECBCS). …