Friday, January 26, 2018

Shiller: What drives these decade-long swings in confidence?

Consumer Confidence Is Lifting the Economy. But for How Much Longer? by Robert J. Shiller Jan. 26, 2018
Amid the constant turmoil in domestic and global politics these days, the economy’s steady expansion has been a source of comfort. But look more closely and you will find that economic growth rests on a surprisingly amorphous base: consumer confidence.
We know that consumer confidence is a critically important advance indicator of economic booms and busts. At the moment, it is forecasting a continuing expansion. Yet the troubling fact is that we don’t fully understand how and why consumer confidence acts as it does.
The simplest explanation is the necessarily slow but consistent recovery from the crushing financial crisis of 2008 and 2009.
There is some truth to that explanation, but it is insufficient. It omits a critical yet elusive factor: animal spirits.
That kind of exuberance now seems to be fueling the stock market, where prices have outstripped fundamental valuations.
Such surges have happened before. The four major confidence indexes took a long ride up between 1990 and 2000...
The critical question, then: What drives these decade-long swings in confidence, including the upsurge that is still underway?

Take the current confidence cycle. While Donald J. Trump’s presidency may have exerted some impact on animal spirits in the last year, it doesn’t explain the preceding eight years of slowly improving confidence. And I am skeptical that the upward swing can be entirely explained by standard factors like government and central bank stabilization policy or technological innovation.
When consumer confidence is falling, people cut back their spending, try to save more, and pay down debt. Debt service costs soon start to fall, and fall for some time.

After a time, the reduced debt burden allows consumer confidence to begin rising again. With increased consumer confidence, spending increases and borrowing increases, perhaps tentatively at first.

The increased borrowing then translates into rising debt service; and rising confidence is able to support it for a while. But eventually the rising burden of debt causes consumer confidence again to fall.

This pattern of behavior fits pretty well with what Shiller says above. It is also clearly visible on the graph below, including the decade of the 1990s and the eight years before President Trump:

Graph #1: Consumer Confidence (blue) and Household Debt Service (red)

Shiller says we don’t fully understand how and why consumer confidence acts as it does.

It's the bills, I say. When the bills start to pile up, consumers lose confidence.

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