Economic environment: Confidence

Data from Timetric.To view this graph, please install Adobe Flash Player. Overlay from Timetric

At some point, you may have thought about the psychological element of the recession. Surely if consumers started buying and businesses started expanding their investment plans, growth would lift off. Unemployment would fall, incomes would rise, suppliers would grow – pushing this virtual cycle forwards.

And you’d be right, to a great extent. The missing ingredient seems to be confidence.

Governments recognise this too: they play an important part in trying to restore confidence. That’s easier said than done, and it’s a topic that’s covered in this BBC article.

You might expect that consumers would feel the least confident when a country was in recession. The recession ended over a year ago, but according to recent consumer confidence data (see above, or read Britons cutting back on spending as confidence falls), it seems to be sliding ever further down (with retailers – optimistic up to Christmas - becoming increasingly pessimistic. Service providers have had a knock to their confidence too).

This is an important consideration. Although GDP figures point to a (weakly) recovering economy, confidence data also gives us an indication of where we might be heading in the months ahead. Notice how confidence figures may be very different in different parts of the economy too. Confidence seems to directly feed through into spending plans, so lower confidence amongst consumers spells bad news for retailers (and their suppliers), not to mention those who provide supporting business services. Manufacturers seem more upbeat. The construction industry is still in despair.

Data from Timetric.

To view this graph, please install Adobe Flash Player.

Overlay from Timetric

Many observers think that the key to (consumer) confidence is what is going on in the labour market. Jobs, incomes and household budgets are strongly drivers of confidence. It’s that vicious (or virtuous) circle again. Growth feeds a stronger labour market, which boosts confidence, which boosts spending…

The economist most famously associated with this idea is JM Keynes (who often referred to confidence as ‘animal spirits’ – see this brilliant rap video) and believed that people acted on “spontaneous optimism” rather than rational considerations of the pros and cons of that action.

It’s hard to know what actually makes people more confident. The royal wedding might make some people feel upbeat and positive but it might fill others with horror, wondering why all this money is being pumped into a big celebration when there are other things that need our attention. The same goes for the Olympics.

A final thought (perhaps suitable for a later blog) is the effect that fuel prices have over people’s outlook. Rising petrol prices are very clearly visible (literally) and make most people poorer, or at least feeling squeezed. Lower pump prices might be just the thing to give the recovery a bit of confidence-driven boost.