What do Hurricane Katrina, the stock market crash of 1987, and the U.S. federal government shutdown of 2013 have in common? They were all shocks that temporarily impacted U.S. consumers and, as a result, consumer confidence. None of these events, however, led to a recession.
As the Consumer Confidence Index has shown over more than four decades, U.S. consumers are very good forecasters of recessions. When large declines in confidence occur, we are thus often asked: Is this just a temporary shock or a precursor to a recession?
A shock event and a recession have distinct impacts on confidence, although both obviously result in declines (Chart 1). The differences lie in the duration of the declines as well as the behavior of the Index's subcomponents. A recession typically causes a prolonged and pronounced drop in confidence. During the Great Recession, the CCI peaked in July 2007 and continued to fall virtually every month before hitting an all-time low in February 2009. During the debt ceiling and U.S. credit downgrade crises of 2011, by contrast, consumer confidence peaked in July, fell sharply the following month, and was on the mend by November.
A shock can produce a sharp decline in confidence, but unlike a recession, the impact is generally short-lived —dissipating, on average, within 1–4 months. Of course, major shocks can cause recessions, and shocks can even occur within a recession, such as the collapse of Lehman Brothers, which exacerbated an already fragile economy and nervous consumer. But shocks during good times are just bumps in the road.
To help us interpret sharp declines in the Consumer Confidence Index, we also look at the behavior of its subcomponents: the Present Situation Index and the Expectations Index (Chart 2). The Present Situation Index measures consumers' assessment of current business conditions and employment conditions. Though it may dip slightly, this index tends to be relatively stable throughout a shock cycle, signaling that the economy remains on track and that consumers are merely experiencing a temporary setback in confidence. Before and during a recession, however, the Present Situation Index will decline sharply and consistently.
The Expectations Index measures consumers' expectations over the next six months regarding business conditions, employment, and income prospects. This index tends to react more strongly than the Present Situation Index during a shock, with declines that are more pronounced. This divergence makes sense; more than immediate impacts, shocks create uncertainty and uneasiness about the near-term future. But, again, the effects are short-lived and very different in both duration and depth compared to the declining expectations seen in a recession.
Most recently, extreme volatility in the financial markets has resulted in a very choppy ride for consumer confidence over the past few months. However, as seen in these historical charts, such bouts of uncertainty and uneasiness are not uncommon and do not necessarily forebode an end to an economic expansion. Heightened uncertainty can lead consumers to postpone purchases or delay discretionary spending, but so far we have seen limited consequences. We can thus conclude that recent drops in consumer confidence have been shocked-induced and driven more by rattled expectations than any actual deterioration in current economic conditions.
Commentary by Lynn Franco, the director for economic indicators at The Conference Board, and among other things responsible for the monthly release of The Conference Board Consumer Confidence Index.
For more insight from CNBC contributors, follow