Forecasting Components of Consumption with Components of Consumer Sentiment
By James A. Wilcox
James A. Wilcox is the Kruttschnitt Professor of Financial Institutions at the Haas School of Business at the University of California, Berkeley. He teaches courses on business conditions, on financial markets and institutions, and on risk management at financial institutions. He has published on banking, housing and mortgage markets, monetary policy, and business conditions. From 1999-2001, he was the Chief Economist at the Office of the Comptroller of the Currency. Previously, he had served as the senior economist for monetary policy and macroeconomics for the President’s Council of Economic Advisers and as an economist for the Board of Governors of the Federal Reserve System. He is a Fellow of the Wharton Financial Institutions Center and a founding Fellow of the Filene Research Institute. He received his Ph.D. in economics from Northwestern University.
We present new evidence that existing, but long-ignored, measures of consumer sentiment can reduce errors in forecasting total consumption expenditures and its components. The component questions of the aggregate Index of Consumer Sentiment improve forecasts, not only of consumer expenditures on durables but also on non-durables and services. Empirical studies have historically focused on whether consumer sentiment improves one-quarterahead forecasts of consumer expenditures. In fact, we document that measures of consumer sentiment are especially predictive at the longer, four-quarter-ahead horizon. In addition, they typically contribute at least as much to one-quarter-ahead and four-quarter-ahead forecasts of consumption as do income and wealth variables. Out-ofsample forecasts for the 2000-2005 period further substantiate that measures of consumer sentiment can reduce consumption forecasting errors appreciably.
This paper won the 2007 E.A. Mennis Contributed Paper Award and was presented at the NABE Annual Meeting in San Francisco on September 10, 2007.
By James A. Wilcox