Index of Consumer Expectations: Food Price Effects and Durable Goods Expenditures

American consumers' subjective expectations about their current and future well-being have been captured in the Index of Consumer Sentiment (ICS) collected and compiled by the Michigan Survey Research Center at the University of Michigan over the last 30 years (Curtain 1973, 1976).(1) A critical assumption behind the survey is that "attitudes and expectations intervene between stimuli and response and they change before behavior changes" (Katona 1978). In other words, knowledge about collective consumer attitudes and expectations should help explain consumer spending and saving decisions and help predict changes in the national economy. There are two schools of thought on this point. A long list of economists dating back to Pigou (1927) have argued that psychological attitudes affect aggregate consumption independently of measurable economic events. Most contemporary (macro) economists, however, find that consumer attitudes do not have much value in forecasting aggregate consumer spending. Most research involving the ICS was conducted prior to 1975 and much of it found the ICS to be a good predictor of aggregate consumption, especially expenditures on durable goods (Adams and Green 1965; Adams and Klein 1972; Dunkelberg 1972; Eckstein 1983; Juster and Wachtel 1972; Klein and Lansing 1955; Mueller 1957, 1963; Shapiro 1972; Tobin 1959). There has been a recent flurry of activity among economists in Federal Reserve Banks trying to determine whether a recent drop in consumer confidence can be used to explain or predict a particularly slow recovery to the 1991 recession. This recent work suggests that when consumer attitudes are highly correlated with real economic variables such as interest rates or unemployment they provide little additional predictive power in forecasting models (Garner 1991; Leeper 1992; Throop 1992). Results of research studies remain mixed, and the debate continues about both the determinants of consumer attitudes and the usefulness of attitudes in forecasting models. The purpose of this study was to examine the components of the ICS, namely the Index of Consumer Expectations (about future well-being) (ICE) and the Index of Current Economic Conditions (ICEC) for their role in determining current expenditures on durable goods. Consistent with the life-cycle and permanent income theories of consumption, which imply that spending is a function of expectations about the future, the ICE was the major focus of inquiry in this study. This paper discusses the overall index of consumer sentiment (ICS) and its components before reviewing studies that have estimated the determinants of consumer sentiment and studies that have attempted to determine its usefulness as a predictor of future economic activity. The research tasks are reported in the order they were conducted; findings from each model are presented in tables and graphs. First, a theoretical model for the ICE was developed in the rational expectations framework. Then the ICE was estimated with a first-difference, polynomial-distributed lag model to determine which macroeconomic and price change variables significantly affected consumers' expectations about their future well-being. Second, the ICE was re-estimated using contemporaneous values for two purposes: one, to compare the results to the first-difference model and two, to provide an estimated value of the ICE to use in a simultaneous model. Third, the impact of the endogenous ICE and the actual ICEC on durable goods expenditures was estimated and compared to earlier studies. It was found that when consumers feel better off in the current period than they expect to feel in the future, current expenditures on durable goods increase. The sentiment about current well-being (ICEC) had a larger impact on current durable goods expenditures than expectations about the future (ICE). THE INDEX OF CONSUMER SENTIMENT AND ITS COMPONENTS Among the five survey questions used to compile the ICS, questions one and five reflect consumers' assessments of current economic conditions and comprise the ICEC; the other three questions focus on expectations about the future and comprise the ICE. …