Internal link - Business confidence key to economic growth – meta analysis

As Ackerlof and Shiller (2008) stressed, confidence plays an important role in predicting economic fluctuations. Hence, we begin our research by testing how confidence affects economic growth. Acemoglu and Scott (1994) and Barsky and Sims (2012) conducted similar research, but they focused on a single country and only studied the role of consumer confidence. To extend their work, we use panel data on 41 countries and add both consumer and business confidence to our regression. Table 2 shows the effect of confidence on economic growth. The following conclusions can be drawn from the results displayed in Table 2. First, a rise in confidence will lead to faster economic growth. As shown in Columns 1–3, innovation in BCI alone can stimulate the economy substantia lly, by 13.2 percent, while innovation in CCI alone can stimulate the economy even further, by 33.4 percent. When we place BCI and CCI together into our regression, the effects of both remain significant. An increase in BCI leads to an increase in GDP growth of 12.3 percent, while an increase in CCI leads to an increase in GDP growth of 22.5 percent. This suggests that confidence is vitally important to economic growth, which is consistent with the ideas of Acemoglu and Scott (1994) and Barsky and Sims (2012). Using panel data on 41 countries, we also find that this rule can be applied to various countries. When market participants become more optimistic on growth, the economy is more likely to experience an economic boom. Second, consumer confidence is more critical than business confidence. The coefficient of CCI, regressed alone or together with BCI, exceeds the coefficient of BCI by at least two standard deviations, implying that economic growth is more sensitive to changes in consumer confidence. This may explain the preference for consumer confidence in previous studies, including that of Acemoglu and Scott (1994) and Barsky and Sims (2012). However, the role of business confidence is also highly significant. When policymakers try to stimulate confidence, this should also involve stimulation of business confidence. Third, confidence affects economic growth through its two main components of consumption and investment. Carroll et al. (1994) and Acemoglu and Scott (1994) found that consumer confidence is useful for predicting consumption. We extend their work by adding the producer side. Thus, we study how consumption and investment react to both consumer and business confidence. Columns 4–6 of Table 2 exhibit how confidence affects consumption, while Columns 7–9 show the effect of confidence on investment. As shown in Columns 4–6, an increase in BCI or CCI alone leads to a substantial increase in consumption growth, by 16.9 percent and 48.4 percent, respectively; this implies that optimistic sentiment among consumers or producers can result in higher consumption. However, when we put both these into the regression, CCI remains significant while BCI does not. This suggests that consumer confidence plays a dominant role in consumption, while producer confidence may be less important. This result is consistent with those of Carroll et al. (1994) and Acemoglu and Scott (1994), who also emphasized the impact of consumer confidence on consumption. Moreover, we find that business confidence also substantially affects consumption, which sheds more light on the determination of consumption. Similarly, we find that BCI or CCI alone has a significant positive effect on investment, as can be seen in Columns 7–9. When we put both these into the regression, both BCI and CCI remain significant, which differs from the result for consumption. Although the coefficient of BCI remains almost unchanged, the coefficient of CCI decreases by more than one standard deviation after we put BCI into the regression. This means that the mood of producers is dominant in investment, while the mood of consumers also plays an important role. Overall, the findings shown in Table 2 suggest that both consumer and business confidence greatly affect economic growth because when agents feel more optimistic about the economy, they tend to decrease their precautionary savings and become more aggressive in consumption and investment. As a result, the economy improves owing to their optimistic behavior. We also find that consumer confidence dominates consumption, while business confidence dominates investment, which is consistent with economic sense. These findings have strong implications for policymakers. As both consumer and business confidence are crucial for economic growth, it is of vital importance for policymakers to take account of the confidence of consumers and producers. This is even more important in times of economic slack, because the lack of confidence during these periods may further discourage economic activity and lead to a deeper recession, as emphasized by Ilut and Saijo (2020). Similar actions have been taken by governments in various countries. After the financial crisis of 2007–2008, forward guidance has become an increasingly important tool of monetary policy (Gertler, 2017; Gokmenoglu & Hadood, 2019; McKay et al., 2016). When the economy hits its zero lower bound, there is no functional role for traditional monetary policy. However, forward guidance can change expectations and thus stimulate agents’ confidence, which will affect economic activity and eventually stimulate the economy without changing the current interest rate. The application of forward guidance proves the importance of confidence, which is also consistent with the idea of Barsky and Sims (2012) that confidence conveys incremental information regarding future economic activity. 4.2. The role of confidence in times of economic boom and recession The results presented in Table 2 show that the confidence of both consumers and producers has a great effect on economic growth. Our results emphasize the importance of confidence, which is highly consistent with previous studies (Acemoglu & Scott, 1994; Barsky & Sims, 2012). Although existing studies have conducted similar research, one important feature of confidence—its asymmetric effect—has been neglected. Confidence may have different effects on economic growth at different times. For example, when an economy experiences an economic slack, economic activities are greatly discouraged because of low levels of confidence; hence, a change of confidence may have a greater marginal effect. As Farmer (2012) has stressed, different levels of confidence can lead to different economic equilibria. To further explore this asymmetric effect, we next analyze whether this effect differs during an economic boom and an economic slack. The study sample is divided into two groups according to the GDP growth of each country to identify this asymmetric impact. Two methods are used for grouping. First, the GDP growth of all sample countries is sorted and the mean GDP growth for each year is measured. The mean growth of GDP can then be used to divide the sample into two groups: the group with GDP growth above the mean is labeled as the booming group and the other is labeled as the busting group. Second, the GDP growth is sorted and the time series mean for each country is measured, from which the sample is again divided into two groups, labeled in the same manner. Table 3 shows how confidence affects economic growth during economic boom and economic slack, using the GDP growth mean of all countries in each year as the grouping criteria. The following conclusions can be drawn. First, both BCI and CCI have a greater effect on economic growth during an economic slack. As shown in Columns 1 and 2, an increase in BCI leads to an increase in GDP growth of 5.9 percent during an economic boom, which is amplified to 15.6 percent during an economic slack. Similarly, CCI also has a greater effect on economic growth during economic slack: the effect of CCI on economic growth is 13.5 percent during an economic boom and 20.2 percent during an economic slack. For both BCI and CCI, the coefficient during an economic slack exceeds the coefficient during an economic boom by at least two standard deviations, confirming the difference between the two groups. The findings suggest that both forms of confidence (BCI and CCI) play an important role in determining economic growth, and that this is amplified during an economic slack, when confidence is more important. Table 3. Asymmetric effect of confidence on economic growth in boom and slack country. This table reports regressions of GDP growth (GDPG) on confidence during an economic boom and economic slack. The average GDP growth of all sample countries is calculated for each year. The BOOM country group means the country’s GDP growth is greater than the average GDP growth, and the SLACK country group means the country’s GDP growth is lower than the average GDP growth. BCI is the Business Confidence Indicator. CCI is the Consumer Confidence Indicator. Control Variables include Inflation, Industry, Trade, AgeDep, PopG, and DomSaving. Country fixed effect and year fixed effect are included. ∗, ∗∗, and ∗∗∗ indicate that the corresponding p-values are less than 0.10, 0.05, and 0.01, respectively. Second, BCI dominates during an economic boom, whereas CCI dominates during an economic slack. In Columns 5 and 6, we add both BCI and CCI into the regression. When GDP growth exceeds the mean growth of all countries, BCI plays an important role while CCI becomes insignificant; when GDP growth is lower than the mean growth of all countries, CCI plays an important role while BCI becomes insignificant. This may suggest that consumer and business confidence have different effects on economic growth. During an economic slack, simulating consumer confidence is more useful, while business confidence contributes more to economic growth during an economic boom. Next, we use the second method to define economic boom and economic slack. Instead of using the mean GDP growth of all countries in each year, we use the time series GDP growth mean for each country as the grouping criteria. Table 4 shows the results, from which the following conclusions are drawn. First, both BCI and CCI have a greater effect on economic growth during an economic slack. As shown in Columns 1 and 2, an increase in BCI leads to an increase of 3.2 percent during an economic boom and an increase of 16.9 percent during an economic slack. As shown in Columns 3 and 4, an increase in CCI leads to an increase of 11.1 percent during an economic boom and an increase of 25.5 percent during an economic slack. The variations of both BCI and CCI coefficients exceed two standard deviations, indicating a significant difference between the two groups. The findings suggest that when GDP growth is lower, confidence will be more effective in stimulating the economy, and this finding is robust across our two grouping criteria. Table 4. Asymmetric effect of confidence on economic growth in boom and slack period. This table reports the regressions of GDP growth (GDPG) on confidence during economic boom and slack. The average GDP growth of each sample country is calculated. The BOOM period group indicates the country’s GDP growth is greater than its average GDP growth. The SLACK period group indicates that the country’s GDP growth is lower than its average GDP growth. BCI is the Business Confidence Indicator. CCI is the Consumer Confidence Indicator. Control Variables include Inflation, Industry, Trade, AgeDep, PopG, and DomSaving. Country fixed effect and year fixed effect are included. ∗, ∗∗, and ∗∗∗ indicate that the corresponding p-values are less than 0.10, 0.05, and 0.01, respectively. Second, BCI dominates during an economic boom, while CCI dominates during an economic slack. In Columns 5 and 6, we put both BCI and CCI into our regression. When economic growth lies above its time series mean, BCI remains significant and CCI does not. Similarly, when economic growth lies below its time series mean, CCI remains significant and BCI does not. The findings also suggest the heterogeneous role of consumer and business confidence. Business confidence is more important during an economic boom, while consumer confidence is more important during an economic slack. These results are also consistent with those shown in Table 3. The results shown in Table 3, Table 4 together prove that both consumer and business confidence are more essential during an economic slack, which is highly relevant for policy and has strong implications for policymakers. Confidence is more important during an economic slack because agents have pessimistic expectations and engage in conservative behaviors in consumption and investment, which makes the economy more sensitive to confidence changes. Ilut and Saijo (2020) pointed out that a lack of confidence can further discourage economic activities, which will trigger a feedback loop and lead the economy into a deeper recession. Zhang (2017) also found that by shutting down the confidence channel, the effect of uncertainty shocks is greatly dampened and less persistent. We echo their idea with support from empirical evidence.