Influences on households' spending, saving and borrowing: confidence

Microeconomic Decision‑makers: Households

Objective

To understand how confidence influences households’ decisions on spending, saving and borrowing.

1. What is “consumer confidence”?

Consumer confidence refers to the overall optimism or pessimism that households feel about their current and future financial situation. It is shaped by:

• Expectations of future income and employment
• Perceived stability of the economy
• Interest‑rate environment
• Inflation expectations
• Recent changes in wealth (e.g., house prices, stock market)

2. How confidence affects the three key decisions

2.1 Spending (Consumption)

When confidence is high, households are more likely to increase current consumption. The basic consumption function can be expressed as:

\$\$

C = a + bY_d

\$\$

where:

• \$C\$ = total consumption
• \$a\$ = autonomous consumption (spending when disposable income \$Y_d\$ is zero)
• \$b\$ = marginal propensity to consume (MPC)
• \$Y_d\$ = disposable income

High confidence raises the autonomous component \$a\$ and can also increase the MPC \$b\$, shifting the consumption function upward.

2.2 Saving

Savings are the portion of disposable income not spent:

\$\$

S = Yd - C = (1-b)Yd - a

\$\$

When confidence falls, households tend to increase precautionary saving, reducing \$a\$ and possibly lowering \$b\$, which shifts the saving function upward (more saving at each income level).

2.3 Borrowing

Borrowing is used to finance consumption when current income is insufficient. The willingness to borrow depends on:

• Expected future earnings (higher confidence → higher willingness to borrow)
• Interest rates (lower rates make borrowing cheaper)
• Credit availability

A simple borrowing decision can be illustrated by the present‑value condition:

\$\$

\frac{Ct}{(1+r)^t} + \frac{C{t+1}}{(1+r)^{t+1}} = \text{Income}{\text{present}} + \frac{\text{Income}{t+1}}{(1+r)^{t+1}}

\$\$

where \$r\$ is the real interest rate. Higher confidence raises the expected future income term, making borrowing more attractive.

3. Summary Table

4. Interaction with Other Factors

Confidence does not act in isolation. Its impact on household decisions is moderated by:

• Interest rates: Even confident households may curb borrowing if rates are high.
• Fiscal policy: Tax cuts can boost confidence, while tax hikes may dampen it.
• Wealth effects: Increases in house or stock market values raise confidence.

5. Suggested Diagram