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Friday, June 19, 2015

How consumer confidence influences the economy

When the Reserve Bank of Australia lowered interest rates, Treasurer Joe Hockey immediately urged Australian households and businesses to make the most of this opportunity, and to borrow, invest and spend.  But why does how we ‘feel’ as consumers matter? And why do policy makers and the RBA care how confident we are in the economy and in the financial decisions we make?

It’s partly because consumer confidence is an important economic indicator, and when the ANZ-Roy Morgan confidence gauge fell 0.9 per cent to an eight-month low in April 20151, it created cause for concern. ‘Confidence’ may seem like a vague term for economic data, but the economy is driven by people – and people don’t always act or spend logically. Our decisions are influenced by our emotions and beliefs, and these decisions affect overall economic performance.

What this means is that measuring consumer confidence is a bit like measuring a ‘vibe’. It’s commonly accepted that economic news influences consumer confidence. Negative headlines about the budget or economy can drive confidence down, while good news might drive it up. And sometimes waves of optimism and pessimism are more unpredictable.

In some ways, it’s a self-fulfilling prophecy. If you as a consumer feel optimistic about the state of the economy, you’ll probably feel more secure in your job. You might believe a pay rise is a possibility or that your investments will go up. Confident consumers are more likely to spend rather than save, driving economic activity. Soon it will start to look like you were right to feel optimistic.

But if you feel pessimistic you’re much more likely to hold tight to your money. When confidence is down, consumers tend to spend less and economic activity suffers.

And that’s when policy makers start to move the levers they can to help stimulate confidence. About half of Australians have a mortgage2, so lowering interest rates puts money back into the pockets of a significant proportion of the population. Rate cuts can also stimulate business investment and, by potentially lowering the exchange rate, help local exporters be more competitive. Whether all this happens as a result of the May interest rate cut remains to be seen.

With all this in mind, it’s not surprising the Federal Budget also aimed to reassure consumers3. So, while consumer confidence looked vulnerable ahead of the Federal Budget, it’s entirely possible the new measures announced on 12 May will do the job of raising confidence in ourselves – even if we’re still not sure about the economy.







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