by Hillary Patin

How Confidence Affects the Economy

We know how confidence affects our daily lives—in particular, how confidence can drive us to make bolder decisions about what we do, say, and even purchase. But confidence is also a driving force in our economy, and can affect everything from job security to investor decision-making.
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Confidence in a nutshell

When people are confident in the economy, they feel secure in their jobs, spend more, and are optimistic. In the same vein, when people lack confidence in the economy, they decide to spend less, save more, and remain pessimistic about jobs and the economy. Confidence is such a driving force in the economy that the media often reports on it—you can watch confidence rise and fall weekly thanks to Gallup Poll’s U.S. Economic Confidence Index, which is based off of asking Americans two questions:

  • How would you rate the economic conditions in the U.S. today?
  • Do you think the economy as a whole is getting better or worse?

Polls like this show how confidence that individuals have in the economy has an aggregate effect, which in turn affects the economy.

How confidence affects the economy

The easily-chartable feeling of confidence can often lead to a boom and bust cycle, the process of economic expansion and contraction that happens repeatedly. Economists argue that understanding confidence (and how to change it in people’s minds) is essential to managing an economy successfully.

Why is it important to manage confidence? Because when panic and worry about the economy set in and filter through the population, recessions can be triggered. When recessions hit, the government will oftentimes have to provide a stimulus package in order to boost employment and spending, as the U.S. government did in response to the recession that lasted from 2007 to 2009. Put simply, the idea is that if there’s an increase in government spending, that extra money will end up in the pockets of others, who will then spend the money and so on, creating a positive domino effect, or multiplier effect.

Economics: not an exact science

Forbes’ Tim Worstall summed it up best in a recent column about consumer confidence, where he said that economics, unlike chemistry, doesn’t always play out the same, because of human forces at play. He says:

“It seems odd to think that something as large as that American economy, all $18 trillion of it, being driven by something as trivial as whether people feel good this month or not. And of course it isn’t driven by that in total. But all economics happens at the margin. And more confident people will save a little less, spend a little more, take a little more risk and just in general take part in more economic activity. So, if everyone does just a little bit more economic activity then there will be more economic activity. And more economic activity is the definition of economic growth. Thus, people wandering down the street and in general thinking “Hey, yeah, I feel good!” means that the economy does in fact grow. And, weirdly, thus they should be feeling good because the economy is going to grow.”

Confidence: proof, once and for all, that faking it ‘til you make it works, even in something as large-scale as the economy.

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