The Financial Crisis 2008
The financial crisis 2008 has shown how much the deviations in consumer confidence can affect economic stability of a country. Being either the root or the result of the crisis, the loss in consumer sentiment is widely agreed to have influenced “the depth and the longevity” of the economic recession, first of all, in terms of the real economy (Dées & Brinca, 2011, p. 5).
Modern economic models give now much more power to this important indicator when forecasting future stock prices, national income, or money supply. Consumer confidence (or consumer sentiment) can be defined as “the degree of optimism that consumers feel in regards to the economy and their personal financial situations” which they express “through their activities of savings and spending” (Investopedia Dictionary, 2013). It takes into consideration personal feelings of each individual in a society toward own current financial position, the situation in the economy in the short run and the predictions for long run economic development.
Consumers are referred to be confident in the economy, if they spend more than they save. While the gross domestic product (GDP) is calculated as the sum of private and government consumption, investment and net export (export less import), the relation to the GDP is straightforward: less consumption leads to lower GDP as fewer goods and services are purchased or demanded to be produced. The situation during the financial crisis was worsened by the fact that consumers did not want to save money in banks or other savings institutions. Besides, low consumption negatively affected firm’s profits and prices of their stocks, thus, making investments even less attractive. This diminished the amount of investment in the economy and further lowered the overall nation’s wealth.
Impact of the Deteriorated Consumer Sentiment on the Interest Rates
Impact of the deteriorated consumer sentiment on the interest rates is traces from the necessity to attract more investments into the economy. It means that banks and other financial institutions have to reduce their interest rates. However, this measure does not appear to be effective for increasing the confidence in saving institutions as general public usually continues to keep money in home safes.
The Money Supply
Another important value influenced by the consumer confidence is the money supply which can be classified from M0 to M4. According to the Financial Times Lexicon (2013), M0 and M1 are referred as “narrow money” and include “coins and notes and other money equivalents that are easily convertible to cash” (e.g., demand deposits, travelers’ checks). M2 is a wider term and includes M1 “plus short-term time deposits and 24-hour money market funds” (savings accounts, time deposits, money market deposit accounts and mutual funds).
Individual savings make money function as a store of value which allows individuals “to save a portion of their present income for consumption in the future” (Mishkin, 1999, p. 34). However, keeping money in home safes cannot be referred to either M1 or M2. This amount of banknotes and precious metals is crossed out of the economy and does not inflow into the value of public investments. This means less money in circulation and negatively influences domestic financial position and real output. Moreover, less money supply moves interest rates and other prices upward leading to artificial inflation in the economy.
Consumer confidence is a very important indicator for the economic stability of a nation. It influences primarily the consumption level, which affects GDP, stock prices, investments, money supply and interest rates. Being uncertain both in the economic health and banking system at the same time, consumers save money at home and cause further recession of the economy. Thus, it is necessary to trace the level of consumer sentiment and implement measures to improve the overall confidence of the society in future.