The link is psychological---changes in business confidence have real macro-economic effects

In 1933, US President Franklin D. Roosevelt pointedly noted that "confidence... thrives on honesty, on honour, on the sacredness of obligations, on faithful protection and on unselfish performance. Without them it cannot live". And over 80 years later these words still resonate with political, policy and business leaders as they grapple with increasingly fickle cycles of consumer and business confidence. To be fair, global policymakers are currently confronting a perplexing set of factors in the aftermath of the financial crisis and major central banks' deployment of unconventional monetary policy via unprecedented asset purchase programs and negative interest rates. Arguably, the crisis of 2008-09 and its legacy continue to cast some doubt on the effectiveness and accountability of policymaking institutions in the major developed economies. Confidence levels in the major developed economies have also been influenced by concerns about the socioeconomic consequences of the unrelenting pressure for ‘structural change’ in an increasingly competitive global economic system. At the household/consumer level, a key concern has been persistently high levels of unemployment faced in some regions and subdued income growth in developed economies, while for businesses, sluggish demand and highly competitive operating conditions continue to influence perceptions of resilience and confidence. Consequently, as the global economy moves into the second half of 2016 it is important to understand the causes and consequences of shifts in consumer and business confidence and the possible implications for the business cycle and macroeconomic policy settings. Confidence may be a case of shifting sands With policymakers in the major economies working hard to restore and maintain confidence levels and shifts in sentiment indicators playing a key role in risk assessments of investors, it is worthwhile to consider the various influences on this qualitative economic measure. Our analysis of the various indicators of consumer and business confidence that are regularly published highlight several common factors that have the potential to cause marked shifts in sentiment; including:

Changes in interest rates and/or exchange rates, particularly if they are rapid, large and unexpected

Swings in the business cycle and associated movements in employment/unemployment levels and business investment intentions

Shifts in the relative prices of nondiscretionary goods and services, notably petrol, healthcare, education and utilities prices

Large external economic and/or financial shocks, such as the financial crisis of 2008/09 and the Eurozone sovereign debt crisis of 2010/11

Announced policy shifts in the stance of government fiscal policy, including large structural spending cuts or increases/decreases in taxation rates.

Interestingly, it is widely accepted by economists that the financial economy operating via interest rates and exchange rates acts as a buffer for the real economy in terms of external shocks, but this effect can often be magnified due to the out-sized impact on consumer and business confidence. For example, Australia was not directly affected by either the financial crisis or the subsequent Eurozone debt crisis, but on both occasions a considerable upsurge in general anxiety and slumping confidence were recorded. Australian households and businesses reported concerns about the economy's vulnerability in the face of unprecedented upheaval in global financial markets. Not surprisingly, in some quarters concerns continue to be expressed that small open economies such as Australia and New Zealand often experience disproportionate reactions to economic and financial disturbances that emanate from much larger and more complex economies, including the US, the Eurozone, Japan, and China. To be sure, we are not suggesting that economic policymakers should maintain inappropriate macro policy settings in order to buoy consumer and business confidence. Rather, the announcement and implementation of shifts in key macro policy needs to be sensitive to the psychological impact on households and firms in the real economy. It is the need to manage psychology that has led the major central banks to bolster their policy 'forward guidance' activities, as they fine-tune strategies to eventually end a period of extraordinary monetary policy accommodation. It's not all in the mind as sentiment shapes activity Although it is often said that 'confidence can turn on a dime', this should not be taken as diminishing the role of sentiment in shaping economic activity and in turn the path of business cycles. The power of confidence was patently demonstrated in late 2008 with the collapse of Lehman Brothers and the subsequent slump in global consumer and business sentiment. This was accompanied by an unprecedented collapse in global trade volumes, industrial production, investment and importantly risk-taking.