South-Western College Publishing - Economics  
Consumer Optimism Plunges as Economy Grows
Subject Consumer Optimism
Topic Productivity and Growth
Key Words

Jobs, Home Ownership, Income and Wealth

News Story

President Bush and Senator John Kerry have been dueling on the state of the American economy. The President boasts that 1.8 million jobs have been added in the last year, and that his tax cuts have put more money in the pockets of the American people and spurred the economic recovery. Senator Kerry points out that real household incomes and employment have both declined under the first Bush administration and the number of people living in poverty rose under his administration. Up to a point, both Bush and Kerry are right. The economy is reported to be growing at a robust annual pace of about 4 percent and no doubt many Americans are enjoying a greater comfort level than ever before.

Home ownership has climbed to a record 69 percent, thanks to the Federal Reserve's decision to keep interest rates low. Additionally, Americans are, on average, living in bigger houses, driving bigger vehicles, surfing the Internet with faster connections, and talking on cell phones more than they did four years ago. Still, other economic indicators suggest that many Americans are poorer than they were four years ago.

"Most American households are financially worse off today than they were four years ago," said Mark Zandi, chief economist tat Economy.com, a Philadelphia research firm. "Median household incomes and median household wealth," he said, "were hit hard by the weak job market, high energy prices and the explosion of mortgage debt."

Americans' standard of living continues to rise, but consumer confidence is not following suit. "Rising living standards are not a new phenomenon," said Ethan Harris, chief economist at Lehman Brothers. "What's different about this period is that the rise in spending is being financed by lower savings and higher borrowing."

So, despite the good news of a growing economy, consumer confidence in the economy has plunged in recent months. The University of Michigan's monthly survey of consumers showed an unexpectedly sharp drop this month, according to preliminary estimates. The Conference Board, which also measures consumer confidence, is expected to show a similar drop when its survey is published. Unless the business sector picks up the slack in consumer spending the result is likely to be a slowing economy.

"Absent a sudden, strong reacceleration in employment growth, we think it is therefore just a matter of time before spending growth slows further," warned Ian Shepherdson of High-Frequency Economics, an independent investment analyst based in Valhalla, N.Y "The risk of a seriously soft holiday season is growing by the day."

(Updated December, 2004)

Questions
1.

Why do you think consumer confidence is such a strong force in the American economy?

2. How do lower interest rates increase home ownership? Find out what the monthly mortgage payment would be (principal and interest only) on a $100,000 if mortgage rates are at 6%, and compare that payment to a loan on the same property with a mortgage interest rate of 10%.
3. If business spending does not replace the loss in consumer spending, do you think the government should come to the rescue? If so, how?
Source Edmund Andrews, "Economy Improves, but Not Optimism," New York Times Online, October 26, 2004.

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