CONSUMER CONFIDENCE AND ECONOMIC GROWTH – A CASE STUDY

BY

KELVIN A SERGEANT

Paper presented at the 4th Biennial International Conference on Business, Banking and Finance – Theme

Restoring Business Confidence & Investments in the Caribbean

June 22 – 24, 2011

Hilton Trinidad and Conference Centre

OBJECTIVES OF THE STUDY

To identify the functional identity of consumer confidence.

To determine the relationship between CCI and economic growth( as well as interest rates and the exchange rate

To determine if a long-run relationship exists (co-integration)

To see if we can make conclusions on based on the psychological framework of consumers

WHAT IS A CONSUMER CONFIDENCE INDEX?

• A consumer confidence index measures how consumers feel about several economic factors. The measure is based on several questions put by an interviewer to the consumer. The result which is represented by a numerical value, speaks to consumers evaluation of their own financial situation, employment chances, expenditure intentions and their opinion of general economic conditions.

WHAT IS THE RATIONALE FOR SUCH AN INDEX?

Consumption is an important determinant in any economy

Personal consumption expenditure usually represents the single largest sector or driver of GDP (income side)

The CCI seeks to gauge consumer spending through consumer sentiment

Consumer confidence is measured or observed through consumer surveys

The most famous and oldest measure of CC is the US survey conducted by the Conference Board and the University of Michigan Consumer Sentiment index

FEATURES OF THE CCI

The CCI may be related to macroeconomic variables such as inflation

Relating the index to macroeconomic variables suggest that confidence is boosted by lower inflation, lower interest rates and higher real income

Consumer confidence is called a lagging indicator in that current behaviour is based on the past and it can take some time to turn around

Enterprises make use of consumer indices to enhance the sophistication of their planning, advertising and marketing strategies.

LIMITATIONS OF THE CCI AS AN INDICATOR OF ECONOMIC WELL

BEING

Economic crisis may affect confidence and not spending, e.g., stock market crash of 1987

The lag effect – consumer confidence either persists after the end of a growth period, or remains depressed after a recession has ended

The Republic Bank/MFO index has the same flaws as most indices

Public sentiment about an occurrence may run counter to spending pattern

Index is still in its embryonic stage

CCI IN THE CARIBBEAN

In the Caribbean only two countries, Trinidad and Tobago and Jamaica continuously measure and track business and consumer sentiment. In Trinidad and Tobago, Republic Bank Limited and Market Facts and Opinions produce the Consumer Confidence Index, and the Arthur Lok Jack Graduate School of Business, University of the West Indies, produces the Corporate Confidence Index. In Jamaica, the Jamaica Conference Board is responsible for both indices.

PREVIOUS RESEARCH One can separate the literature on consumer

confidence into three distinct approaches. The first argues that there is a significant and

strong relationship between consumer sentiment and consumption expenditures (carroll et al. 1994).

The second fails to find any supportive evidence of empirical significance, rejecting the validity of consumer confidence as a leading indicator (Garner, 1991).

The third uses some form of unconventional methodology to bridge the gap between qualitative survey data and quantitative analysis, resulting in favourable (Jansen and Nahius, 2003) and non-favourable evidence (Dominitz and Manski, 2004).

However, the common point of all these studies is to focus on the explanatory power of consumer confidence thus restricting it to the role of an exogenous variable.

OUR APPROACH

This paper also employs some unconventional methodology by assessing the determinants of consumer confidence in Trinidad and Tobago so that the functional identity of consumer confidence is revealed. This is important for three reasons.

a favourable finding will mean that in Trinidad and Tobago, consumers behave different due to the dynamic economic structure;

second, consumer confidence measures in Trinidad and Tobago should be considered with care (rather than just some data); and

last, we will have insight into the psychological frame work of consumers in emerging markets where there is certainly a difference between ability to buy and willingness to buy.

METHODOLOGY OF THE REPUBLIC BANK/MFO CONSUMER CONFIDENCE

INDEX

The Survey is conducted door-to-door, with a randomly selected nationally representative sample of 500 households

The neighbourhoods used in the sample were randomly selected over the broad areas of North East, North West, Central and South Trinidad, and Tobago.

The MFO/Republic Bank Consumer Confidence Index is based on consumers’ opinions of current and expected personal finances, business conditions and purchasing conditions. The Index of Current Consumption (ICC) and the Index of Consumption Expectation (ICE) are incorporated in the Index of Consumer Confidence or Index of Consumer Sentiment (ICS).

BEHAVIOUR OF VARIABLES IN THE STUDY

METHODOLOGY OF STUDY Basic Regression model:

CCI= C + GDP + ER + IR + u t

Determine whether a long run equilibrium relationship exist between consumer confidence and GDP (cointegration). A necessary condition for cointegration is that these

series must be non stationary and integrated of the same order.

Apply the Perron Unit Root Test to establish whether variables are non-stationary

Establish the direction of causality using the Granger- Causality test

Apply the Impulse Response function to observe the behaviour of the endogenous variable to external shocks to any of the exogenous variables

RESULTS OF THE UNIT ROOT TESTS

Variable Level First Difference

CCI -6.098 ……….

∆GDP -6.530 ……….

IR -5.352 -6.389

ER -10.939 ……….

5% critical value -5.590 -5.590

The results indicate that the CCI, ∆GDP and ER are stationary in levels, while IR is non-stationary in levels. Hence, a long run equilibrium relationship among the variables cannot be established

RESULTS OF THE GRANGER-CAUSALITY TEST

Bivariate Model 1: The null hypothesis that CCI does not Granger–cause GDP is rejected at 5% and 10% level of significance. Also the null hypothesis that GDP does not Granger-cause CCI is also rejected at the 5% and 10% level of significance. This means that GDP helps to predict CCI and CCI helps to predict GDP.

Bivariate Model 2: the null hypothesis that CCI does not Granger-cause IR is rejected at the 10% level. However, the null hypothesis that IR does not Granger- cause CCI is accepted at levels of significance. Therefore it can be concluded that, that while CCI helps to predict interest rates, interest rates does not help predict consumer confidence.

Multivariate Model. The results indicate that CCI helps

predict GDP and vice versa. It also indicates that GDP to a small extent helps predict the exchange rate. However, the exchange rate and the interest rate do not help to predict any variable in the model

RESULTS OF THE IMPULSE RESPONSE FUNCTION

The response of consumer confidence to a shock in GDP will initially lead to a drop in consumer confidence in the first and second quarters, however, the consumer confidence will trend towards positive as the lag increases.

This justifies the CCI variable as a lagging indicator and supports our belief that initially, CCI will not respond to increases in GDP, but after a period of time, there will be a positive response in accordance with a priori expectations depending on economic theory. We note also the negative response of the interest rate variable again in line with our initial expectations.

RESPONSE TO CHOLESKY ONE S.D. INNOVATIONS

-.1

.0

.1

.2

1 2 3 4 5 6 7 8 9 10

Response of LCCI to LCCI

-.1

.0

.1

.2

1 2 3 4 5 6 7 8 9 10

Response of LCCI to DLGDP

-.1

.0

.1

.2

1 2 3 4 5 6 7 8 9 10

Response of LCCI to IR

-.1

.0

.1

.2

1 2 3 4 5 6 7 8 9 10

Response of LCCI to ER

-.02

-.01

.00

.01

.02

.03

1 2 3 4 5 6 7 8 9 10

Response of DLGDP to LCCI

-.02

-.01

.00

.01

.02

.03

1 2 3 4 5 6 7 8 9 10

Response of DLGDP to DLGDP

-.02

-.01

.00

.01

.02

.03

1 2 3 4 5 6 7 8 9 10

Response of DLGDP to IR

-.02

-.01

.00

.01

.02

.03

1 2 3 4 5 6 7 8 9 10

Response of DLGDP to ER

-1.0

-0.5

0.0

0.5

1.0

1 2 3 4 5 6 7 8 9 10

Response of IR to LCCI

-1.0

-0.5

0.0

0.5

1.0

1 2 3 4 5 6 7 8 9 10

Response of IR to DLGDP

-1.0

-0.5

0.0

0.5

1.0

1 2 3 4 5 6 7 8 9 10

Response of IR to IR

-1.0

-0.5

0.0

0.5

1.0

1 2 3 4 5 6 7 8 9 10

Response of IR to ER

-.02

-.01

.00

.01

.02

.03

.04

1 2 3 4 5 6 7 8 9 10

Response of ER to LCCI

-.02

-.01

.00

.01

.02

.03

.04

1 2 3 4 5 6 7 8 9 10

Response of ER to DLGDP

-.02

-.01

.00

.01

.02

.03

.04

1 2 3 4 5 6 7 8 9 10

Response of ER to IR

-.02

-.01

.00

.01

.02

.03

.04

1 2 3 4 5 6 7 8 9 10

Response of ER to ER

Response to Cholesky One S.D. Innovations ± 2 S.E.

CONCLUSION

We found that consumer confidence can have an endogenous nature and has a strong relationship to GDP.

However, in our model, we found only a short-run relationship as the results of the tests led us to conclude that CCI, GDP and ER are stationary in levels while IR is non-stationary in levels.

the series had different order of integration and as such, a long-run relationship among the variables could not be established.

We therefore support the use of the consumer confidence index as a short-run policy variable

THANK YOU