The Relationship between Consumer Confidence and the Strength of the American Economy

Abstract

This paper argues that consumer confidence is what buoys the American economy and that a downfall in confidence leads to disastrous economic outcomes. The author's experience at O'Keefe & Associates Consulting inspired him to take a closer look at the role of consumer confidence in American markets. The analysis is divided into four parts: a comparison of the stock market in the 1920s versus the 1990s, a comparison of corporate scandals then and now, a statistical examination of the role of consumer confidence, and an answer to the likelihood of another Great Depression occurring. Part one of the research section examines stock market activity from the "Roaring '20s" and the Great Depression in comparison to the Internet boom of the 1990s and the crash of 2000. This analysis concludes that consumer confidence was responsible for the sharp rise and decline in stock market levels. During each stock market boom, Americans, in general, held three main beliefs: it was possible to get rich quickly; technology was profoundly changing the business world; and business leaders were trustworthy. This led to an irrational exuberance in both periods that caused an overvaluation in stock prices. When the bubble finally bursted in both periods, consumer confidence declined sharply, the stock markets plunged, and there were severe economic losses. Part two of the research section shows how consumer confidence upholds corporations. It examines four companies: Middle West Utilities and Kreuger & Toll of the Depression era and Enron and WorldCom of today. When consumer confidence was high, they grew to unsustainable levels. During these high growth periods, these companies failed to improve their core business because the vast networks they created were too difficult to manage. To cover up for their weaknesses, they all resorted to fraudulent accounting, and they all met their demise when consumer confidence spiraled downward along with the economy. Part three of the research section provides a time series, correlation, and regression analysis of consumer confidence in relation to various economic indicators. The statistical analysis concludes that consumer confidence is a leading economic indicator that tends to foreshadow future economic performance (Rogers 1994, 249). GDP growth and durable goods sales have the strongest relation to consumer confidence according to the time series analysis. Correlation tests showed that consumer confidence has a strong positive correlation with motor vehicle sales, consumer spending, GDP, the performance of the S&P 500 Index, and home sales. The regression models show that consumer confidence can be used to explain GDP and motor vehicle sales. The paper ends with a discussion on the likelihood of another Great Depression occurring. This analysis concludes that while the economic environment today is alarmingly similar to the environment in 1929, especially considering the bursting of the Internet bubble and the presence of corporate scandals, the chances of another Great Depression occurring are extremely small. Even though consumer confidence has fallen dramatically and there is a wealth concentration similar to the 1920s, the American government learned the importance of sound fiscal and monetary policy from its errors during the Great Depression, thus making a repeat virtually impossible.