What is consumer sentiment, and what does it tell us?

If you tune into any financial-related news, you are bound to hear some mention of 'consumer sentiment.' In May, for instance, it was reported that consumer sentiment had hit "a six-month low" and "notched its biggest drop since 2021, reflecting the persistent tug of inflation on household budgets and fueling fears that rising prices, unemployment and interest rates could all worsen in the coming months," said The Washington Post.

While you may be able to infer well enough what the phrase refers to, what is not quite as readily apparent is how exactly consumer sentiment is measured — and why it's a metric that matters.

What is consumer sentiment?

Broadly speaking, "consumer sentiment is an economic indicator that measures how optimistic consumers feel about their finances and the state of the economy," said Investopedia. Effectively, this indicator "predicts changes in economic activity based on how likely consumers are to buy things, often in the next 12 months," said The Balance.

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There are "two key measures that express consumers' feelings about the economy and their subsequent plans to make purchases," said Investopedia: "the Consumer Confidence Index (CCI), prepared by the Conference Board (CB), and the Michigan Consumer Sentiment Index (MCSI), conducted by the University of Michigan." These are both "based on a household survey and are reported on a monthly basis."

How is consumer sentiment determined?

Consumer sentiment is determined by, well, surveying consumers. More specifically, surveyors ask consumers "if they are likely to spend money in the next few months to compile an aggregate view," said The Balance.

The Index of Consumer Sentiment is "derived from" five different questions, said NerdWallet. These questions range from asking whether people would say they "are better or worse off financially" compared to a year ago, to if they think "during the next twelve months we'll have good times financially," to whether they think "now is a good or bad time for people to buy major household items."

The Conference Board's Consumer Confidence Index also "issues a five-question survey," said NerdWallet. These questions are then used "to calculate three distinct indexes: the Consumer Confidence Index, the Present Situation Index, and the Expectations Index," with the Consumer Confidence Index representing "the average index for all five questions" — meaning, effectively, consumer confidence is gauged based on feelings about the present conditions and expectations for those in the future.

While historically, the Index of Consumer Sentiment has been conducted "by phone," beginning in July 2024 "they'll be conducted online, with researchers aiming for 900 to 1,000 respondents," said NerdWallet. The sample size for the Consumer Confidence Index is "roughly 3,000 respondents."

What does consumer sentiment tell us about the overall economy?

So what exactly do Americans' perceptions of the economy actually tell us about the economy? "Consumer sentiment can be used as an early predictor of economic changes," said NerdWallet. As it turns out, "how people feel about the economy can directly impact the economy, because consumers' attitudes often affect how much they spend on things like food, transportation, household goods, entertainment and more."

In other words, said Investopedia, "if people are confident about the future they are likely to shop more, boosting the economy," whereas if they are "uncertain about what lies ahead, they tend to save money and make fewer discretionary purchases." When consumers are not feeling so great about the state of the economy, that in turn "weakens demand for goods and services, impacting corporate investment, the stock market, and employment opportunities, among other things."

That said, while consumer sentiment can be a helpful guideline, it is not a definite predictor of the future of our economy. As The Balance said, "consumers are not clairvoyant, and news events can turn consumer sentiment in no time." For example, while in February 2020, "the Michigan Surveys of Consumers index stood at 101," by "April, after the initial coronavirus lockdowns took effect, the index had slid to 71.8."