Consumption as a Leading Indicator

Abstract

This article shows that real, total consumption growth deviations from normal stock market wealth effects lead economic growth. Consumers’ expenditures reflect their information about employment opportunities and future real wage growth, as well as information about the volatility of future investment returns. Previous research has shown that stock prices and the slope of the term structure of interest rates reflect forecasted economic growth and profits. It is shown that consumption deviations improve growth forecasts based upon the signals given by the term structure and stock returns over the 50-year period from 1961 to 2011 and in the recent (2006-2009) volatile period of rapid growth followed by financial panic. Putting the information from the stock market, the bond market and consumers together, we find that all three key variables are statistically significant in regressions and out-of-sample simulations and have a combined explanatory power that rivals the Conference Board’s venerable Index of Leading Economic Indicators.