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Back-to-School Will Test the Economy's Strength

by Dennis Jacobe

Consumer confidence declines even as economists tout second quarter results


PRINCETON, NJ -- On July 29, the Commerce Department reported that the U.S. economy grew at a 3.4% annual rate during the second quarter as consumer spending increased at a 3.3% annual rate. While these numbers are down from the first quarter, they represent a strong economic performance, particularly in light of the fact that retail gasoline prices averaged $2.23 a gallon during the second quarter, compared to $1.97 during the first three months of the year.

While the economy's performance from April to June produced euphoria on Wall Street, Gallup's consumer confidence measures declined at the end of July. The Conference Board's Consumer Confidence Index also showed a decline for the month, while the University of Michigan's Consumer Sentiment Index remained essentially unchanged.

So, why aren't consumers more optimistic about the future of the U.S. economy? Will consumers continue to spend even if their confidence level continues to decline? What is the outlook for back-to-school sales?

Perceptions of Current Economic Conditions

According to a July 25-28 Gallup Poll, the percentage of consumers rating the economy "good" or "excellent" declined from 36% in early July to 32% at the end of the month. At the same time, the percentage rating the economy "poor" increased to 23% from 18% earlier in the month. The current difference of 9 percentage points (percentage good/excellent minus percentage poor) is at its lowest point since early May. It is also far below the 24 percentage-point difference registered in January and early February.

Consumer Expectations

Fifty-three percent of consumers say current economic conditions in the country as a whole are "getting worse" in late July, compared to only 35% who say they are "getting better." This difference of -18 percentage points (percentage getting better minus percentage getting worse) is about where it was in early July, but far below the positive differences recorded in January and early February.

Why Aren't Consumers More Optimistic?

Four in 10 Americans say they are worried about their families' finances right now, with 15% saying they are very worried and 25% saying they are somewhat worried. In spite of two good quarters of economic growth, this percentage is up slightly from the 38% measured in February.

One reason so many consumers continue to worry about their family finances involves gas prices. Although the economy's second quarter performance led some on Wall Street to declare that the U.S. economy can do very well even with oil prices at $60 a barrel, a closer look at gasoline prices suggests differently. Gasoline prices hit $2.28 on April 11, according to the U.S. Energy Information Administration. Shortly thereafter, gas prices fell steadily from their April peak, declining to $2.10 a gallon by the end of May. Since then, gasoline prices have increased once more and averaged $2.29 a gallon at the end of July -- up $0.40 from one year ago.

The drop in gas prices led to an improvement in consumer confidence and consumer spending as the second quarter progressed. Recent increases in gas prices, however, are doing just the opposite. Given increasing prices at the pump, it is easy to see why consumer confidence is declining.

Will Wealth Effects Spur Back-to-School Spending?

Of course, the question for back-to-school shopping is whether the current weakening in consumer confidence will translate into a decline in retail sales. Normally, barring a surge in employment in the near term or a rash of significant discounting like that taking place in the automobile industry, one would assume that falling consumer confidence would mean declining retail sales.

The current economic situation could be different, however, because of today's wealth effects. Many consumers feel richer because of the gains they have made as the value of their homes and their equity investments have surged. Since these equity gains are easily liquefied in today's economy by way of home equity loans and lines of credit, they could provide an added stimulus to consumer spending. However, increasing interest rates and growing debt levels may combine with higher prices at the pump to discourage spending even among these better-off consumers.

On the other hand, the numerous consumers who are not enjoying the wealth gains being created in the current economy are probably the best explanation of how consumer confidence can remain weak even as the overall economy performs well. These consumers are unlikely to increase their spending in the face of increasing pump prices.

In sum, the strong performance of the U.S. economy during the first two quarters of this year does not necessarily guarantee more of the same, or something even better, during the remainder of 2005. Instead, increasing gas prices, higher interest rates, and declining consumer confidence suggest just the opposite. In this context, the real test of the economy's underlying strength is likely to be consumer back-to-school spending.

Survey Methods

Results are based on telephone interviews with 1,010 national adults, aged 18 and older, conducted July 25-28, 2005. For results based on the total sample of national adults, one can say with 95% confidence that the maximum margin of sampling error is ±3 percentage points. In addition to sampling error, question wording and practical difficulties in conducting surveys can introduce error or bias into the findings of public opinion polls.


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