AUSTRALIA'S BUSINESS CHALLENGES: Here's how to understand consumer sentiment

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In an economy where people matter more than things, consumer confidence – like its cousin business confidence – gives an insight into what people are thinking and that in turn can send a powerful signal on how they will then act. The choices these consumers make flow through into other areas.

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Mining has taken all the headlines over the past decade. First the mining investment boom helped rescue Australia from the worst aspects of the global financial crisis by providing a much needed boost to economic growth and output. Then the collapse of this boom, a collapse that is ongoing, left the economy with the loss of a growth engine, threatening the economic outlook.

With this in mind, you’d be forgiven for thinking that mining, and mining investment was Australia’s biggest industry, and employer. But Australia is not a mining based economy. Rather it is a diversified service based economy which (excluding construction) means the service sector accounts for more than 70% of real gross value added. The structure of the economy also means that most Australian’s are employed in the services sector and in turn that also means consumers, and consumption, are an important part of the economy.

Our e-book, Australia’s Business Challenges.

As a result, consumer sentiment is one of the most watched indicators by economists and those interested in the health of the Australian economy. Not just because household consumption is the largest single component of GDP, but because of the insight it gives to other areas of the economy – investment, savings, labour market conditions, and even house prices.

Think about the aggregate impact of the purchasing decisions people make about new cars, new housing, how often people go to restaurants or decide to take holidays in Australia rather than head overseas, buy furniture and white goods, and opt for small luxuries or bargain hunt.

Behavioural economists are increasingly understanding that it is this linkage between confidence – how people feel – and their actions, whether to consume or sit on the sidelines, that powers the domestic part of the economy.

The first method is to directly observe the outcomes in the economy and then draw inferences about what that means for economic growth. This is a powerful tool. But it is in some respects backward-looking — telling us what has come before, with some lag time. So while this method is an important part in understanding where the economy is situated, it is more explanatory than something that helps economists, government, the RBA and – importantly – businesses forecast the future.

To remedy this problem a number of forward-looking surveys of consumer confidence are produced by various institutes and financial institutions, in order to better gauge the outlook for the domestic economy.

This is an excerpt from Australia’s Business Challenges, a free e-book from Business Insider. Get your own copy below:

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