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Consumer confidence and recessions: another economic fallacy
Frank Shostak
Most economists subscribe to the view that rising consumer confidence boosts outlays and in turn the entire economy. Likewise a growing business confidence gives rise to a greater capital expenditure which in turn lifts the overall economic activity. Since confidence is such an influential factor it is important, so it is held, not to upset the psychology of individuals.
Whenever economists then discuss the state of the economy, they are always trying to portray the bright aspect of it. Even when the economy falls into a recession, various influential economists are very guarded in their speech regarding this fact. Some of them have even replaced the word recession with expressions like a sideways movement or a gentle pause, or that the economy is heading for a soft landing. Again the main reason for this gentle talk is a view that by means of a soft language individual's confidence will not be upset.
Is it valid to argue that individual's actions are driven by confidence? According to the great Austrian economist Ludwig von Mises, the driving force of human action is the faculty of thinking or the logical mind. It is by means of the mind that every individual, if he chooses so, can ascertain the facts of reality. Once these facts have been identified the individual then can decide what actions he must undertake in order to raise his well being. The so called confidence, which is also labelled as sentiment or feelings, cannot be of assistance to individuals in finding out what the facts of reality are.
For instance no feeling, or sentiment or confidence is capable to establish that all other things being equal, an increase in the demand for apples will raise their prices. This can only be ascertained by means of a logical thought process. So whenever it is suggested that confidence drives the economy, it must mean that individuals have abandoned their faculty of thinking and acting like robots.
In order not to undermine individuals confidence, or sentiment most mainstream economists advocate that government and central bank policies must be transparent. For if everybody will become aware of these policies, then these policies will not have destabilising effects on individual's sentiment and hence on the economy, so it is held.
Let us assume that the government presents a plan to raise personal taxes. How can the fact that this plan is made known to everybody, prevent erosion of individual's living standards? Even if politicians would succeed to convince people that the tax increase is good for them, this cannot alter the fact that individual's after taxes incomes will be reduced. Or if the central bank makes it public knowledge, that it will lift the money growth, can the economic deterioration from the increase in the money stock be averted by keeping people's confidence high?
In assessing the state of the economy, most economists make extensive use of consumer surveys. According to the mainstream thinking, the health of the economy can be assessed by probing opinions of randomly selected individuals regarding the state of the economy. Somehow, it is held, the collective response or the collective mind of all those surveyed will reveal the truth. Some analysts even maintain that the collective mind can tell not only what is happening at present but can even provide a clue about the future. There is no reason at all to regard various confidence or sentiment surveys as the basis for the assessment of the state of the economy. Only if individuals surveyed could present their reasoning, only then we could ascertain the validity of their responses.
Can the fall in consumer confidence plunge the economy into a recession? Now, the fall in so called confidence must be regarded as people's views about the facts of reality. However, people's opinions cannot alter these facts. All that opinions manifest is what people think about the facts of reality. So if people have discovered that things are not rosy as they have previously thought, they will alter their opinions i.e. their confidence will be much lower.
However, this cannot make things worse than what they are. Now, if individuals follow their faculty of thinking and ascertain what the facts of reality are, they adjust their conduct accordingly. If however, they follow their feelings or their sentiment then the likelihood of them identifying the facts of reality is very low. However, irrespective of whether individuals are successful in identifying the facts of reality or not, these facts will assert themselves.
Thus, if we have identified that the real pool of funding is declining, then this is a fact of reality. Regardless of people's views and their confidence it is this fact that will force the decline in consumer outlays. In other words the fall in consumer outlays is not caused by the fall in consumer confidence but by the fact that the real pool of funding cannot afford any longer previous levels of outlays.
Dr Shostak is a former professor of economics who now works in the private sector
BrookesNews.Com
Monday 7 January 2008