Abstract
Two channels through which stock prices can affect consumption are wealth effects and shifts in consumer confidence. We examine the evidence for the latter channel for Canada, using consumer confidence survey data. The composition of households’ financial wealth between stock and pension funds holdings as well as the unique 6-month forecast horizon in the consumer confidence survey make Canada a particularly interesting case relative to the USA and the European countries. We find that both stock price changes and their volatility are significant predictors of consumer responses to questions that are unrelated to expectations of future personal finances, even after controlling for inflation, unemployment and interest rates. Moreover, there is a significant short-term increase in consumer pessimism after an unexpected rise in stock market volatility. Overall, the evidence for the confidence channel suggests that this channel can amplify the effects of the well-understood wealth channel. Consequently, it should be taken into account in determining quantitative impacts of the stock market on consumer behavior.
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Notes
The confidence channel was first proposed by Romer (1990).
While our discussion is framed in terms of increasing stock prices, a fall in stock prices is expected to have the symmetric opposite impact on consumer behavior.
Our data sets are available as a supplementary material (Online Resources 2–4).
We are grateful to the anonymous referee for suggesting the second measure.
Jansen and Nahuis (2003) found that monthly confidence indices were integrated of order one in the European countries. Consequently, they worked with the differences of stock prices and confidence measures. Otoo (1999) also examined a relation between the differences of consumer confidence and stock price measures in the USA, even though she did not discuss the results of unit root tests explicitly.
More specifically, 9.9 % of the households reported to own stocks, and 14 % invested in mutual funds, investment funds or income trusts (Statistics Canada 2005).
Otoo (1999) was able to implement such strategy for the USA using individual observations from the University Michigan’s survey of consumer sentiment.
Recall that \(\Delta \)SP3 measures the stock price changes between the third months of each quarter, the periods when the consumer opinions are determined. The values of \(\Delta \)SP32 equal the stock price changes between the third and the second months of each quarter.
CANSIM series v2062815, v41690973 and v122530.
Our results for the responses of stock prices and consumer confidence measures to an expected shock to stock market volatility are qualitatively robust to the use of the specifications in levels as well as to the use of the monthly data.
The confidence bands were computed using the procedure mcvardodraws in RATS.
These results hold even after controlling for other economic indicators, such as the unemployment, inflation and interest rates.
For example, an article by “Stock Market Begins to Feed Economic Fear” appearing in the The New York Times on August 21, 2011, highlights a potential negative impact of “plunging stocks” and “dismal economic news” on housing purchases and quotes several analysts whose views are consistent with the consumer confidence channel.
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Acknowledgments
We thank two anonymous referees for helpful comments and suggestions. We also thank Todd Crawford from the Conference Board of Canada for clarifying several questions regarding the data construction methodology.
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Karnizova, L., Khan, H. The stock market and the consumer confidence channel: evidence from Canada. Empir Econ 49, 551–573 (2015). https://doi.org/10.1007/s00181-014-0873-z
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DOI: https://doi.org/10.1007/s00181-014-0873-z