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RAY SUAREZ: Consumer spending is up; consumer confidence is down; uncertainty in the American economy; more uncertainty in today’s numbers: The American consumer’s spending and saving habits are closely watched for telltale signs of how the economy is doing today, and may be doing tomorrow. Joining us are three consumer watchers. Richard Curtin is the director of the Consumer Survey at the University of Michigan, which issued its monthly report today. Lynn Stout teaches law and economics at Georgetown University. And Drazen Prelec is a psychologist who studies consumer behavior and teaches at the MIT Sloan School of Management.
Richard Curtin, that number is down precipitously from its peek of just a year ago. What goes into the consumer sentiment number and the consumer expectation number? What does it measure?
RICHARD CURTIN: The Index of Consumer Sentiment measures the changes people have in the optimism or pessimism they see in their future financial situation. The index is composed of five questions, constructed more than 50 years ago: Two of the questions on personal finances, two on the outlook for the national economy, which reflects people’s overall prospects for future income and job growth; and one question on buying conditions, which reflects people’s sense of price and interest-rate trends on their buying plans.
RAY SUAREZ: And in that 20-point drop from last April, are there some of those five questions that have declined more than others, some parts of consumers’ self-diagnosis that has remained stronger than others?
RICHARD CURTIN: Well, consumers are very concerned about rising unemployment from slow economic growth, and the outlook for the national economy suffered significantly through February of this year. More recently, people’s assessments of their own financial situation declined significantly. At the present time we have a third of all households who think their financial situation worsened during the past year.
RAY SUAREZ: Is there a split in how people diagnose their own situation — between their own situation and how they see the economy at large, friends, neighbors, their town, their region?
RICHARD CURTIN: In early phases of downturn, people tend to think that others will be hurt by unemployment more than they will themselves. And that’s certainly true in this situation. Consumers are fairly upbeat about their own personal finances; nonetheless, they think unemployment is going to rise and rise close to 5 percent by the year end.
RAY SUAREZ: Drazen Prelec, is there a sense in which these numbers about sentiments, about feelings, about expectations are every bit as real as the hard numbers that economists like to work with, auto sales, refrigerator sales, borrowing, spending?
DRAZEN PRELEC: Well, we know from previous evidence that consumer sentiment, especially their fears about unemployment, does have a real impact on their future spending. So what we don’t know is whether consumers’ concerns really are a form of playback of what they hear in the popular press about lay-offs because it’s certainly not monitoring unemployment statistics. But statistically it has been shown that when consumers become nervous about their own job prospects, they will actually cut back on spending.
Now, the current evidence is — what’s really interesting about the current situation is that consumers are relatively optimistic. They’re relatively happy about their current economic situation. Still, they’re pessimistic about what is going to happen six months from now. But that hasn’t yet affected their purchasing plans even for the big ticket items. So they seem to be on target in terms of spending even though their forecasts are relatively pessimistic.
RAY SUAREZ: So, when it comes to something like sentiment or forecasts, do you believe that major American players could, for instance, talk down the economy?
DRAZEN PRELEC: Oh, I think that’s happened. I think what you’ve seen in the last six months has been something like equivalent to an advertising attack campaign against the U.S. economy. Partly this was driven by objective factors, partly by political statements, and I think consumers to a large extent — when they’re asked about what’s going to happen to the economy six months from now– are feeding back the information they’ve heard in the popular press.
Now, just because they’re feeding it back doesn’t mean this isn’t going to have a real impact at some point. It’s not having a real impact yet. But it could have it if it persists. And this would be — I think one thing we have to watch out for is if consumption really starts to break down it’s going to be quite hard to get it back to current levels. Consumers, once their confidence wilts, there’s an asymmetry in their response. They’re not going to come back as quickly as they’ve cut back on spending.
RAY SUAREZ: Lynn Stout, do you find consumers to be reliable canaries in the coal mine? Do they know something is up often before economists do?
LYNN STOUT: Well, in this case we have got a very peculiar situation where consumers are saying one thing and behaving in another fashion entirely so it’s not quite clear what the canary is doing in this case. Part of it may be the hypothesis that people tend to be overoptimistic about their own prospects. This is the "unemployment is what happens to somebody else" theory. But there may be something else going on that has to do with the wealth effect that we’ve heard so much about from the Federal Reserve.
People may be a little bit more worried about job prospects generally. They may even be more worried about job prospects for themselves. But in the past five years the stock market has put a tremendous amount of money into people’s pockets, even with the latest bubbles and breaking of the bubble, you’ve seen about $10 trillion in wealth created over the past five years. It may be, it seems to me it’s plausible, that even though people feel that their employment prospects are a little more iffy, particularly in the short run, they’re still feeling like they’re in pretty good shape, they’re pretty wealthy, and they’re ready to spend.
RAY SUAREZ: You heard Richard Curtin has measured a decline in consumer sentiment and expectations. Last Friday we got the news that the gross domestic product increased faster in this first quarter of this year than last year. We recently got the news that home sales were posting new records. How do all these inputs mesh? Do they seem to run on the same track with you?
LYNN STOUT: I don’t think they mesh very well. So the question is, what is the answer to the puzzle? Are people optimistic about their own prospects and pessimistic about everyone else’s, or could it be that concerns about the economy generally and about employment generally are not as relevant as they were before the stock market put lots of money in your pocket?
RAY SUAREZ: Go ahead, Richard Curtin.
RICHARD CURTIN: I sort of disagree with that interpretation. It is certainly true that the wealth effect has played an important part in determining the decline in savings rates and the strength in consumer spending. On the other hand, if you look at the details of the first quarter data, sales declined through the quarter of… from January to March — March was negative and the savings rate increased by half a percent.
People are concerned about the future of their financial situation and they have taken some action to redress these concerns. Just because the consumers don’t react immediately is not an indication that there isn’t a concern and that they will not react in the future. I think we’ll see that April sales — vehicles — are very poor, decline substantially from the first quarter average, and the other point is that interest rates have declined significantly since January, a very rare occurrence during the first phase of this slowdown. And that’s why home sales have been so positive and why vehicle sales have been positive.
But now consumers’ concerns about their future financial situation are causing them to even cut back on vehicle purchases — and not that I expect a recession from what we’re seeing. In fact, the Index of Consumer Sentiment is still above its long-term average — but that there will be a prolonged period of slow economic growth that the consumer will be part of.
RAY SUAREZ: How do you respond?
LYNN STOUT: Well, I think that that is certainly… Part of that is… makes quite a bit of sense. Traditionally, historically there is a lag between the bad economic news coming out in the numbers and consumers eventually responding. And it could be that we will see a period of slow growth. But I think there’s a more optimistic scenario that is possible; and that is that absent some dramatic negative change in the economic fundamentals — real spike in commodities prices, energy prices — it may be that people’s willingness to spend, based perhaps in part on recent wealth gains, will sustain the economy and basically keep us from seeing a very bad downward spiral. We could pull ourselves up by our own bootstraps to some extent.
RAY SUAREZ: Alan Greenspan recently said that he was watching the consumers’ sentiments numbers very closely because he thought they were highly predictive, as opposed to other feedbacks that we get from the economy. What do you think about that?
LYNN STOUT: Well, we’ll find out. We’ll see how long the lag is and whether or not that shows up six months down the road.
RAY SUAREZ: Richard Curtin, watching consumer sentiments as opposed to prices and sales and other more traditional indices?
RICHARD CURTIN: Well, I think that watching consumer sentiment is an important test for any forecaster, but we should expect, for example, some of the positives that were just mentioned not to occur. We expect some energy problems this summer — a rising price of gasoline which will hit consumers particularly hard because now gasoline may go over $2 a gallon and other problems with the cost of electricity. So we’re certainly not out of the woods, and there is many further troubles that will affect consumer confidence.
RAY SUAREZ: Drazen Prelec, people are assumed to be experts about their own lives. When they are reporting one thing about themselves and doing another, does one eventually have to catch up with the other? Will they start feeling the way they’re spending or spending the way they’re feeling?
DRAZEN PRELEC: Well, you know, it’s very easy to change your opinion about how the economy is heading because that’s just an intellectual response. But when you have to actually cut back consumption, that hurts. So it makes very good sense that consumers are going to try to persist in their consumption patterns in the face of economic uncertainty as long as they can.
On the other hand when they’re asked questions of sentiment on sentiment surveys it’s an intellectual response and they can essentially, it’s like taking a test, they can repeat the information they’ve heard. But cutting back spending is a very painful gesture. One thing we have seen recently is a rise in credit card debt, which is not really matched by a comparable rise in consumption. What could be happening, what people suspect might be happening is that consumers are financing more of a necessary routine expenditures off of their credit cards which can’t go on indefinitely.
RAY SUAREZ: Lynn Stout, watch the dead overhang?
LYNN STOUT: I think it’s very important. There are two parts to the economy really. There are the economic fundamentals but there is a psychological layer. For example, it seems pretty plausible that when you get — fall on hard economic times, those times can be made much worse if people respond by putting their money in a coffee can under the bed, taking it out of the stock market and refusing to spend. And probably it works perhaps to a far more limited degree in the other direction. But the fact is the economic fundamentals do matter, and if there are… if there is more economic bad news — higher commodities prices, higher energy prices — consumers are spending more than they’re bringing in. And that is creeping up credit levels, that will have an effect. You can’t deny reality forever.
RAY SUAREZ: Lynn Stout, Drazen Prelec, Richard Curtin, thank you all.