Consumer Confidence and Household Investment

Household investment displays a robust leading indicator property over the US business cycle. It has been challenging to account for this stylized fact. In this paper, we develop the hypothesis that consumer confidence drives household investment. Using a surveybased consumer confidence measure for 1960Q1–2017Q4 we find that it leads household investment by two quarters and housing starts by one quarter, lending support to the hypothesis. We then use VAR analysis to identify a confidence shock. Household investment increases and follows a persistent hump-shaped response after a positive confidence shock. The responses of total hours-worked and output also show a persistent increase and so do real house prices. Confidence shocks account for a substantial share of variation in household investment, total hours-worked and output. We show that household investment plays a quantitatively important role in the transmission of confidence shocks in the economy. Moreover, confidence shocks do not appear to be related to movements in future fundamentals, total factor productivity and the relative price of investment, representing supply side developments. Our findings, therefore, suggest that demand side forces originating in consumers’ social and psychological factors may be a fruitful direction for studying household investment dynamics and their relationship with the business cycle.