ABSTRACT
The Index of Consumer Sentiment (ICS) compiled by the University of Michigan’s Survey Research Center (SRC) has often been found to move similar to the business cycle path of the U. S. economy. The 1990-91 recession has been widely attributed to a drop in consumer confidence in the wake of Iraq’s invasion of Kuwait. 1 The index has typically led other business cycles as well, and three of its five components are explicitly included in the Conference Board’s Index of Leading Economic Indicators. 2 Numerous studies have found the ICS to be helpful in predicting consumption expenditures both on durables and nondurables. However, no definite consensus has emerged as to why measures of consumer sentiment such as the ICS have such explanatory power, or what is it that the index actually captures - consumers’ perception of the overall uncertainty in the economy, their optimism or pessimism about future economic conditions, or expectations about personal economic factors (Mishkin 1978). Many studies have investigated the relationship between the ICS and observable macroeconomic variables at the aggregate level using time-series techniques. They find that in normal times a very large proportion of the movement in the ICS can be explained by movements in such economy-wide variables as the inflation and unemployment rates, recession headline news, and the job rating of the existing administration (Lovell 1975, Blood and Phillips 1995). However, in times of unusual aggregate uncertainty econometric models of sentiment seem to break down as sentiment wanders away from the current macroeconomic variables, and a very large proportion of the variation in the index remains unexplained.
