Consumer sentiment dips - what is the significance?

Consumer spending makes up the largest part of Aggregate Demand (AD) in virtually any economy. In Australia is is roughly two-thirds of AD or GDP.

We know that disposable income is a primary determinant of consumer spending (C = a + cY), but there are other factors that affect it. A really important one is consumer confidence. When consumers feel that the future holds security in terms of jobs and income they are prepared to spend a higher proportion of their current income and borrow more money.

When consumer confidence is low we can expect households to be cautious. They spend a lower proportion of current income, 'just in case' and repay debt rather than borrow more. This will lead to lower overall consumer spending. This will naturally impact on AD, and so GDP and so economic growth.

The Westpac Melbourne Institute Index of Consumer Sentiment is the best known measure of consumer confidence in Australia. In March it fell by 2.2% to a figure of 99.1. When the figure is less than 100 it means that on balance there are more pessimists than optimists.

While such a move is not a signal that AD and so GDP will fall it does mean that growth will be slower than it would otherwise have been.

Uncertainty is usually the cause of low consumer confidence and these figures point to uncertainty on economic policy, a view that the property market might not be such a good investment and volatile financial markets all contributed to lower confidence.

This fall in consumer confidence is a demand side factor that will influence the Australian economy. It is a drag on Aggregate Demand because consumption is such a large component of it and will influence policy makers, such as the RBA, when it comes to interest rate decisions.

Macro business report the data in detail here 

This article is very important to VCE students who need to keep track of this data throughout the year and be able to discuss demand side influences on the economy and policy. IB students will recognise this as an important example to use when talking about AD, how it influences the economy and the effectiveness of fiscal and monetary policy.