Thursday, November 15, 2012

U.S. Consumer Sentiment Rises to Pre-Recession Levels

 Economists track the Thompson Reuters-University of Michigan Consumer Sentiment Index (Consumer Sentiment Index) to understand how consumers perceive their personal finances, overall business conditions, and other buying conditions. The Consumer Sentiment Index measures consumer confidence, which helps predict the direction of consumer spending. Consumer spending is important because it has the potential to support an economic recovery (an increase in consumer spending increases overall demand, which indicates that output and employment will improve in the near future). This is why economists, like David Sloan, an economist for 4Cast in New York, were pleasantly surprised after Thompson Reuters-University of Michigan announced that the Consumer Sentiment Index reached its highest level in five years.

The Consumer Sentiment Index rose to 83.1 in October 2012. This is significant because the October Index level moves consumer sentiment closer to non-recessionary levels. During non-recessionary periods, the average Consumer Sentiment Index level is 87.9, while during recessionary periods it is 69.3. The October Index level of 83.1 is much closer to non-recessionary levels and marks the Index’s highest point since before the country’s recent recession.

The Consumer Sentiment Index rose because consumers either are richer or they perceive themselves to be richer. Consumers are richer because more consumers are employed and have an income. The unemployment rate dropped to its lowest level in the past four years—7.8%. Consumers perceive themselves to be richer (a phenomenon called the “wealth effect”) because property prices across the country have increased—property prices jumped to $187,300, which is almost a 10% increase over last year—and stock prices reached their highest level since 2007—13.9% increase this year alone. Since consumers either are richer or they perceive themselves to be richer, they will likely spend more, which is an encouraging sign for the country’s general economy.

Economists question whether the increase in consumer sentiment is sustainable in light of future economic uncertainties, such as the effects of the European debt crisis and the looming fiscal cliff (simultaneous increase in tax rates and decrease in government spending). The business sector is also skeptical, as shown by its low sentiment level. The Institute for Supply Management index (an indicator of business sentiment that measures activity in both the manufacturing and services sectors) was 51.7 in October 2012, which represents only a 0.2 increase from its level in September 2012 (51.5) and is only slightly higher than 50.0—the dividing line between expansion (a positive sign for business sentiment) and contraction (a negative sign for business sentiment) in these sectors. Despite these uncertainties, consumers continued to express confidence in the economy as the Consumer Sentiment Index climbed to 84.9 in November 2012. Moreover, this trend seems likely to continue as the Consumer Expectations Index—a measure of consumers’ economic expectations six months in advance—increased from 79.0 in October 2012 to 80.8 in November 2012, which marks the highest level since July 2007. 

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