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Consumer Sentiment: Its Rationality and Usefulness in Forecasting Expenditure - Evidence from the Michigan Micro Data

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  • Nicholas S. Souleles

Abstract

This paper provides one of the first comprehensive analyses of the household data underlying the Michigan Index of Consumer Sentiment. This data is used to test the rationality of consumer expectations and to assess their usefulness in forecasting expenditure. The results can also be interpreted as characterizing the shocks that have hit different types of households over time. Expectations are found to be biased, at least ex post, in that forecast errors do not average out even over a sample period lasting almost 20 years. People underestimated the disinflation of the early 1980's and in the 1990's, and generally appear to underestimate the amplitude of business cycles. Forecasts are also inefficient, in that people's forecast errors are correlated with their demographic characteristics and/or aggregate shocks did not hit all people uniformly. Further, sentiment is found to be useful in forecasting future consumption, even controlling for lagged consumption and macro variables like stock prices. This excess sensitivity is counter to the permanent income hypothesis [PIH]. Higher confidence is correlated with less saving, consistent with precautionary motives and increases in expected future resources. Some of the rejection of the PIH is found to be due to the systematic demographic components in forecast errors. But even after controlling for these components, some excess sensitivity persists. More broadly, these results suggest that empirical implementations of forward-looking models need to better account for systematic heterogeneity in forecast errors.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8410.

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Date of creation: Aug 2001
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Handle: RePEc:nbr:nberwo:8410

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Cited by:
  1. Dimitrios D. Thomakos & Gikas A. Hardouvelis, 2007. "Consumer Confidence and Elections," Working Paper Series 42-07, The Rimini Centre for Economic Analysis, revised Jul 2007.
  2. N. Gregory Mankiw & Ricardo Augusto Marc Rocha Reis & Justin Wolfers, 2004. "Disagreement about Inflation Expectations," Yale School of Management Working Papers ysm391, Yale School of Management.
  3. Christopher D Carroll, 2001. "The Epidemiology of Macroeconomic Expectations," Economics Working Paper Archive 462, The Johns Hopkins University,Department of Economics.
  4. Sagarika Mishra, . "Do Agents Learn by Least Squares? The Evidence Provided by Changes in Monetary Policy," Financial Econometics Series 2012_09, Deakin University, Faculty of Business and Law, School of Accounting, Economics and Finance.
  5. Yu, Ge, 2005. "Excess sensitivity of consumption using micro data in the UK," MPRA Paper 548, University Library of Munich, Germany, revised 2006.
  6. Sean Nicholson & Nicholas S. Souleles, 2002. "Physician Income Prediction Errors: Sources and Implications for Behavior," NBER Working Papers 8907, National Bureau of Economic Research, Inc.
  7. Robert Rich & Joseph Tracy, 2003. "Modeling uncertainty: predictive accuracy as a proxy for predictive confidence," Staff Reports 161, Federal Reserve Bank of New York.
  8. Frijters, Paul & Haisken-DeNew, John P. & Shields, Michael A., 2002. "Individual Rationality and Learning: Welfare Expectations in East Germany Post-Reunification," IZA Discussion Papers 498, Institute for the Study of Labor (IZA).
  9. Dudek, Sławomir, 2008. "Consumer Survey Data and short-term forecasting of households consumption expenditures in Poland," MPRA Paper 19818, University Library of Munich, Germany.
  10. Dion, David Pascal, 2006. "Does Consumer Confidence Forecast Household Spending? The Euro Area Case," MPRA Paper 911, University Library of Munich, Germany.
  11. Brigitte Desroches & Marc-André Gosselin, 2002. "The Usefulness of Consumer Confidence Indexes in the United States," Working Papers 02-22, Bank of Canada.
  12. Nicholas S. Souleles, . "Household Securities Purchases, Transactions Costs, and Hedging Motives," Rodney L. White Center for Financial Research Working Papers 24-99, Wharton School Rodney L. White Center for Financial Research.
  13. Yu, Ge, 2003. "Comparing Expectations and Outcomes: Application to UK Data," MPRA Paper 502, University Library of Munich, Germany, revised 2005.
  14. Jürgen Maurer & André Meier, 2005. "Do the "Joneses" really matter? Peer-group versus correlated effects in intertemporal consumption choice," IFS Working Papers W05/15, Institute for Fiscal Studies.
  15. Roberto Golinelli & Giuseppe Parigi, 2003. "What is this thing called confidence? A comparative analysis of consumer confidence indices in eight major countries," Temi di discussione (Economic working papers) 484, Bank of Italy, Economic Research and International Relations Area.
  16. C. Alan Garner, 2002. "Consumer confidence after September 11," Economic Review, Federal Reserve Bank of Kansas City, issue Q II.

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