Tuesday, August 11, 2009

Not All Kinds of Consumer Confidence Are Equal

With the worst of the financial crisis seemingly over, economists and talking heads are now looking at the path to recovery--a path they say depends on so-called "consumer confidence." The title of Fareed Zakaria's recent article basically sums up the spirit: "Get out the wallets: The world needs America to shop."

As someone who has studied a little economics, I understand where they are coming from. Consumption spending comprises roughly 2/3 of GDP, and the American market is one of the biggest in the world. As businesses see higher volumes of sales, they are able to higher more workers, make investments, and circulate the money back into the economy, which keeps us all afloat. On paper, the numbers present a convincing argument.

The problem, though, is that the numbers do not translate into sustained, long-term, healthy prosperity. For example, having scores of people buy houses they cannot afford would certainly count as consumer confidence, but no one would say that is healthy or desirable. The same goes if everyone maxed out their credit cards and buried themselves in debts. Instead, these are the very problems that the financial crisis so starkly exposed, and, if anything, the severity of the panic should teach us not to make those mistakes again. Rather than reading headlines about negative savings rates and massive foreclosures, I think most of us would like to see households stay in/move into good financial well-being, make prudent investments, and take other steps to ensure long-term financial security. National prosperity, after all, begins with personal prosperity, and personal prosperity depends in large part on sound spending habits.

The key, as always, is moderation. Households do need to enter the marketplace, but they should do so in a level-headed way. The numbers from this level-headed approach may not look as good as those generated by "irrational exuberance," but, lest we forget, 5 years later that's not what we'll be caring about.

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