Confidence Shocks Research Articles

How to interpret consumer confidence shocks? State-level evidence

Using novel quarterly data of 29 U.S. states from 2005:I to 2015:IV, we revisit the link between consumer confidence and economic activity. We find that an innovation in consumer confidence is followed by a significant and persistent increase in consumption and output but a temporary decline in inflation. These findings suggest that the supply-side (news) interpretation of consumer confidence receives more empirical support than the demand-side (animal spirit) interpretation in our sample.

Confidence spillovers, financial contagion, and stagnation

Financial crises tend to spread across countries, causing equity price crashes that cannot be fully explained by fundamentals. This paper introduces a two-country dynamic general equilibrium model of global financial crises that distinguishes between interdependence and financial contagion. Interdependence arises through trade and capital flows, while contagion occurs through a new channel: confidence spillovers. In the model, contagion is possible due to multiple dynamic and steady-state equilibria, even with fully rational consumers. Self-fulfilling beliefs about equity prices can shift the economy between equilibria, amplifying negative effects and causing contagion. The model has three policy implications. Firstly, monetary policy can offset recessions without causing inflation. Coordinated international policy can potentially improve welfare further. Secondly, capital controls can prevent contagion. Lastly, increased trust in government can mitigate negative confidence shocks. These recommendations emphasize the role of beliefs, where pessimism can spread internationally via the confidence channel, leading to contagion.

Total factor productivity in East Asia under ambiguity

Most cross-country empirical studies on economic growth ignore ambiguity. We argue that ambiguity should matter a priori, given the open-endedness of growth theories. Moreover, ambiguity has received a lot of attention since the great financial crisis (GFC) of 2008, and more recently after COVID-19 and the war in East Europe. Using annual data from the Penn World Table covering 12 East Asian economies from 1954 to 2019, we show that beyond economic factors documented in the current debate about the East Asian miracle, economic agents' confidence shocks about the global economy (one dimension of ambiguity) have a significant negative impact on total factor productivity (TFP) growth. However, correlation uncertainty (another dimension of ambiguity) is low in the region given the persistent high level of connectedness of its productivity network. The empirical results are policy-relevant given that ambiguity, unlike rational expectations, implies that economic agents’ beliefs are not policy invariant.

Влияние на новите глобални рискове върху търговските вземания и междуфирмената задлъжнялост в страните от Източна Eвропа

Following the conflict of Ukraine, global trade has faced a double whammy: a confidence shock in demand, as well as increasingly high price pressures. High energy prices, geopolitical tensions, and increased transportation bottlenecks rank among the basic concerns for the existence of business in Eastern European countries. These challenges will tighten financing and will exacerbate interfirm debt problems, resulting in a number of insolvencies that will continue to increase in the coming quarters. In this complex political, financial, and economic environment, with constantly emerging new crises and risks, business may only survive if it restructures itself and properly adapts to the new reality.

How Important Are Consumer Confidence Shocks for the Propagation of Business Cycles in Bulgaria?

ABSTRACT This article takes an otherwise standard real-business-cycle setup with a government sector, and augments it with shocks to consumer confidence to study business-cycle fluctuations. A surprise increase in consumer confidence generates higher utility, as the household values consumption more in that scenario. As a test case, the model is calibrated to Bulgaria after the introduction of the currency board (1999–2018). We find that shocks to consumer confidence by themselves cannot be the main driving force behind business cycle fluctuations, but when combined with technology shocks, model performance improves substantially. Therefore, allowing for additional factors, such as consumer confidence, to interact with technology shocks can be useful in explaining business cycle movements.

Asset prices in a labor search model with confidence shocks

This paper studies a labor search model with agents who are averse to ambiguity (Knightian uncertainty). Shocks to confidence about future productivity are modeled as changes in ambiguity. Using the Survey of Professional Forecasters data, I find that confidence shocks help explain the equity premium and the stock market volatility, including their term structure. Ambiguity amplifies the response of the economy to productivity shocks, helping the model produce more realistic dynamics of unemployment, vacancies, labor market tightness, stock prices, and returns. Returns in the model are predictable with price-dividend ratios; both returns and dividends are predictable with unemployment, like in the data. Two extensions consider shocks to bargaining power and to separation rate and find similar implications of ambiguity about these shocks.

The Effects of Securitization for Managing Banking Risk Using Alternative Tranching Schemes

Diversification practices by banks affect their own risk of failing and the risk of the banking system as a whole (systemic risk). A seminal theoretical work has shown that linear diversification can reduce the risk of a bank failing, but at the cost of increasing systemic risk. Later, a follow-up study showed that a particular strategy of securitization with tranches can help avoid this trade-off. We extend the theoretical work on securitization by considering all possible strategies for securitization with two tranches, by finding their corresponding optimal diversification solutions, and by discussing their implications for individual and systemic risk. We show that securitization that involves exchanging a portion of both tranches brings back the dark side of diversification. In addition, we also show how different strategies of securitization can have risk amplification effects among banks when confidence shocks occur.

Financial wealth, investment, and confidence in a DSGE model for China

Based on a DSGE model, we investigate the interconnection between China’s stock market and macroeconomic cycles. Our results show that consumption, investment, and capacity utilization exhibit significant and positive responses to stock market booms triggered by the financial and confidence shocks, while the responses of inflation are more muted and insignificant. There is a significant ‘leaning-against-the-wind’ reaction of China’s monetary policy to the credit-to-GDP gap at business cycle frequencies. Decomposing stock prices into fundamental values influenced by the financial shock and bubbles driven by the confidence shock, the confidence shock’s contribution to stock return fluctuations is estimated to be 14.8%.

Asset Prices in a Labor Search Model with Confidence Shocks

Asset Prices in a Labor Search Model with Confidence Shocks

The COVID-19 consumption game-changer: Evidence from a large-scale multi-country survey

Prospective economic developments depend on the behavior of consumer spending. A key question is whether private expenditures recover once social distancing restrictions are lifted or whether the COVID-19 crisis has a sustained impact on consumer confidence, preferences, and, hence, spending. The elongated and profound experience of the COVID-19 crisis may durably affect consumer preferences. We conducted a representative consumer survey in five European countries in summer 2020, after the release of the first wave’s lockdown restrictions, and document the underlying reasons for households’ reduction in consumption in five key sectors: tourism, hospitality, services, retail, and public transports. We identify a large confidence shock in the Southern European countries and a shift in consumer preferences in the Northern European countries, particularly among high-income earners. We conclude that the COVID-19 experience has altered consumer behavior and that long-term sectoral consumption shifts may occur.

The Effects of Investor Confidence Shocks on Business Cycles

This paper extends a quantitative medium-scale New-Keynesian DSGE model with financial intermediaries to account for shocks to investor confidence. Shocks of this nature manifest themselves as per period changes to financial intermediaries' leverage ratios. A Bayesian MCMC approach is utilized to estimate the base and extended model, including shock process parameters, for the U.S. economy using five macroeconomic time series from 1984 through 2019. The estimation results suggest that confidence shocks have a large and sustained effect on the real economy. Overconfidence initially provides a boost to the economy but this effect subsides and then triggers a prolonged recession. In the base model, a decomposition of U.S. output growth into its constituent shocks shows that the effect of negative shocks to capital quality contributed significantly to the financial crisis of 2008. However, this effect is muted in the extended model suggesting that shocks to confidence were important contributors to the output gap during the Great Recession.

Rational Expectations Models with Higher-Order Beliefs

This paper develops a general method of solving rational expectations models with higher order beliefs. Higher order beliefs are crucial in an environment with dispersed information and strategic complementarity, and the equilibrium policy depends on infinite higher order beliefs. It is generally believed that solving this type of equilibrium policy requires an infinite number of state variables (Townsend, 1983). This paper proves that the equilibrium policy rule can always be represented by a finite number of state variables if the signals observed by agents follow an ARMA process, in which case we obtain a general solution formula. We also prove that when the signals contain endogenous variables, a finite-state-variable representation of the equilibrium may not exist. For this case, we develop a tractable algorithm that can approximate the solution arbitrarily well. The key innovation in our method is to use the factorization identity and Wiener filter to solve signal extraction problems conditional on infinite observables. This method can be used in a wide range of applications. We demonstrate its strong practicability by solving several classical models featuring higher order beliefs, and also a full-blown business cycle model that is driven by confidence shocks.

The COVID-19 Consumption Game-Changer: Evidence from a Large-Scale Multi-Country Survey

Prospective economic developments depend on the behavior of consumer spending. A key ques- tion is whether private expenditures recover once social distancing restrictions are lifted or whether the COVID-19 crisis has a sustained impact on consumer confidence, preferences, and, hence, spending. The elongated and profound experience of the COVID-19 crisis may durably affect consumer preferences. We conducted a representative consumer survey in five European countries in summer 2020, after the release of the first wave’s lockdown restrictions, and doc- ument the underlying reasons for households’ reduction in consumption in five key sectors: tourism, hospitality, services, retail, and public transports. We identify a large confidence shock in the Southern European countries and a shift in consumer preferences in the Northern Eu- ropean countries, particularly among high-income earners. We conclude that the COVID-19 experience has altered consumer behavior and that long-term sectoral consumption shifts may occur.

The COVID-19 Consumption Game-Changer: Evidence from a Large-Scale Multi-Country Survey

Prospective economic developments depend on the behavior of consumer spending. A key question is whether private expenditures recover once social distancing restrictions are lifted or whether the COVID-19 crisis has a sustained impact on consumer confidence, p references, and, hence, spending. The elongated and profound experience of the COVID-19 crisis may durably affect consumer preferences. We conducted a representative consumer survey in five European countries in summer 2020, after the release of the first wave’s lockdown restrictions, and document the underlying reasons for households’ reduction in consumption in five key sectors: tourism, hospitality, services, retail, and public transports. We identify a large confidence shock in the Southern European countries and a shift in consumer preferences in the Northern European countries, particularly among high-income earners. We conclude that the COVID-19 experience has altered consumer behavior and that long-term sectoral consumption shifts may occur. JEL Classification: D12, D81, D84, E21, E60, E71, G51, H30

International Transmission of Confidence Shocks

This paper investigates the role of global confidence cycles, measured as the common factor across a wide range of business or consumer confidence indicators, on macroeconomic and financial fluctuations in 40 countries. I estimate a factor-augmented vector autoregression model, where global confidence shocks are identified through recursive restriction. I report two main results. First, the global confidence cycle has played a key role in macroeconomic fluctuations, explaining over a quarter of total variation in industrial production and unemployment rates over 1985-2019, based on median across countries. Second, the transmission of global confidence shocks to domestic variables was significant in most countries although it was more pronounced in advanced economies than in emerging market and developing economies.

Brazil

The COVID-19 pandemic has worsened Brazil’s longstanding vulnerabilities of low potential growth, high income inequality, and weak fiscal position. While the authorities mounted a rapid and effective response to support the economy and protect the poor and vulnerable, the virus outbreak is yet to be brought under control. Outlook and Risks. Real GDP is projected to contract by 5.8 percent in 2020 followed by a partial recovery to 2.8 percent in 2021. With weak domestic demand, inflation is likely to end 2020 substantially below target. Debt is projected to jump to 100 percent of GDP, due to a 10.6 percentage point deterioration in the primary deficit in 2020, and continue to rise over the next five years. The high level of debt exposes Brazil to confidence shocks. Securing congressional passage of structural reforms to raise potential growth remains challenging.

Confidence Swings and Sovereign Risk Dynamics

This study investigates the time-varying determinants of Italian sovereign risk using a Markov-switching structural vector autoregression, estimated on 1990–2018 monthly data. Sign restrictions are used for identification, and allow macroeconomic fundamentals and confidence-related factors to be characterized as separate and regime-dependent drivers of risk. We show that the latter becomes relevant during a crisis regime, when a negative confidence shock triggers demand-like macroeconomic disruptions, and sharp increases in sovereign spreads. Changes in fundamentals, that is, fiscal, supply and demand shocks, are unable to directly explain episodes of sovereign risk surges. Counterfactual simulations highlight the prevailing role of regime-dependent dynamics, where confidence switches tend to characterize the historical evolution of sovereign risk premia and reversals in spreads cyclicality.

International confidence spillovers and business cycles in small open economies

The economic literature has for a long time been looking for explanations of a very strong international correlation of business cycles. This paper shows empirically that common fluctuations can to some degree be the effect of confidence shocks being transmitted internationally. We focus on a large (euro area) and a small, nearby economy (Poland). Our results show that euro area confidence fluctuations account for approximately 40–70% of business cycle fluctuations both in the euro area and in Poland. More importantly, their transmission happens not only via traditional channels (e.g., by confidence affecting euro area GDP and then Polish GDP via trade), but to a large extent occurs directly (e.g., by news spreading via media).

Global Confidence, Uncertainty, and Business Cycles

This paper investigates the role of global confidence cycles, measured as the common factor across a wide range of survey-based business or consumer confidence indicators on global macroeconomic fluctuations. I estimate a factor-augmented vector autoregression model, where global confidence shocks are identified through recursive restriction. I report three main results. First, the global confidence cycle, in particular that of consumer confidence, has played a key role in global business cycle fluctuations, explaining over a third and over a half, respectively, of total variation in global industrial production and employment over 1985-2019. Second, the results suggest that while global business confidence or uncertainty shocks are in nature demand-driven, global consumer confidence seems to reflect macroeconomic shocks in both demand and supply sides, in line with “animal spirit” and “news” views on the relation between confidence and economic activities. Third, the empirical results suggest that the plunges in economic confidence caused by the COVID-19 pandemic have led to around 25 percent decline in global industrial production by the end of 2020. The results are robust to the ordering of variables or alternative identifying schemes that include external instrument identification.

Macroeconomic effects of consumer confidence shock – evidence for state dependence

Purpose The purpose of this paper is to investigate the impact of a consumer confidence shock on GDP and different types of consumer spending during a slack state as well as a non-slack state of an economy. Design/methodology/approach The authors use the US quarterly data from 1960Q1 to 2014Q4 and apply Jorda’s (2005) local projection method to compute the impulse responses of macroeconomic variables to a consumer confidence shock. The local projection method allows us to include non-linearities in the response function. Findings In general, the response of output, following a consumer confidence shock, is similar in slack and non-slack states and indicate that an unfavorable confidence shock is contractionary. However, the intensity and duration of impact of a confidence shock on different components of spending are state dependent. Overall, a negative confidence shock appears to have a stronger impact on non-slack time than on a slack time. Practical implications Policy makers should be careful about undertaking a policy action that may affect consumer confidence adversely, particularly during an economic good time. An adverse confidence shock can trigger a downfall in a well-functioning economy and the dampening effect may last for several quarters before the economy rebounds. Originality/value US economy is subject to fluctuations; however, the literature on the impact of confidence shock in different economic states is limited. The incremental contribution of this paper is that it investigates how the consumers respond to the confidence shock in a state-dependent model. Furthermore, the authors use a more robust and alternative estimation method that tackles any non-linear problems.