Consumer Confidence: The Role it Plays in GDP and Economic Growth

Written by John Henning

The largest concern in any market – bull or bear – is economic growth. Typically, people stress disposable income levels as the sole determinant of increasing consumption and, subsequently, economic growth. However, this benchmark is far from the truth. While, yes, the level of disposable income is an incredibly important aspect of consumption, the determinant that bears the greatest precedence is consumer confidence – essentially the consumer's marginal propensity to consumer (MPC). The bottom line is simple: if I'm a consumer, and I don’t have confidence in the economy, I'm going to save my surplus income not spend it – my marginal propensity to save (MPS) is greater than my MPC. Unless there is consumer confidence in the market, an increase in income will not increase consumption.

            There's no greater example than the present. As seen over the past few months – especially with the growth and great upward trend of the last quarter – the economy is growing, consumption is on the up-swing. The greatest sign of this came in the last quarter of the 2012 fiscal year. Households' borrowing increased to an annualized "rate of 2.4% in the final three months of 2012" (Shah, 2013)  – this is the greatest increase since 2008 based on Federal Reserve (the Fed.) reports, says the Wall Street Journal article, "Freshly Flush, the Consumer Is Back," by Neil Shah. Borrowing, obviously a sign in increased consumption, is a great indicator of economic growth, this is the case for a few reasons. First off, the obvious: household wealth has increased. Simple as that. The assumption of origin is true, households have more money. Check out these graphs from the Wall Street Journal for specifics.

Second, this shows the banks are lending, money is circulating through the economy, and most importantly, the monetary multiplier is in effect. More money is being created, lent by banks, spent on consumption, deposited, and it's a continuous circle – a circle of economic growth. This is the most important aspect for today's discussion. Borrowing is the proof that the consumers in the US economy have their confidence back. They are now willing to assume the risk and make investments (see above), they are willing to take money out on loans, they are willing to consume. Yes, it is true, this economic growth could not have come without an increase in disposable income. However, it was not the increase in income that implemented this growth – the increase in MPC acted as the hand, increasing consumption, creating economic growth. And, this is no blimp on the radar, people "continued to borrow in January" (Shah, 2013). Furthermore, Americans acquired "more debt for the first time since the throes of the recession" (Shah, 2013). There can be no doubt, this increase in economic growth is coming from Americans who are "more willing to borrow and spend, pumping up the economy" (Shah, 2013).

This great increase in consumer confidence came from two sources: increasing values in the stock market and increasing real-estate values (see above graphs). The rebounding real-estate market is "playing a key role" (Shah, 2013) in consumer confidence. When this, the initial cause for recession, turned, many Americans started to feel safer spending a little more. With it is the stock market recovery, that is making many Americans pockets feel a little deeper.

Consumer confidence is of the utmost importance. You can lead a horse to water, but you can't make him drink. You can put a million dollars in someone's pockets – but unless they have confidence, unless they have a propensity to consumer – they won't spend it.    

Bibliography:

Shah, N. (2013, March 8). Freshly Flush, the Consumer Is Back. The Wall Street Journal , p. A3.