Does Consumer Sentiment Forecast Household Consumption? Evidence from Korean Household Data

This paper examines whether consumer sentiment index (CSI) is useful in forecasting household consumption using a composite CSI from the Bank of Korea. Empirical analysis is conducted based on a consumption model proposed by Carroll et al. (1994), where consumption is the function of lagged values of CSI and a vector of other macroeconomic variables. According to the regression results, consumption model augmented by CSI explains 76.4% of the variation in consumption growth, which is 3.6%p higher than the baseline model with only the conventional macroeconomic variables. In the case of service expenditures, the adjusted R² improves by 7.3%p when consumer sentiment is included in the model. Out-of-sample forecasting tests provide further support to this evidence as the forecasting error of the CSI augmented model is lower than that of the baseline model. Empirical results of this paper suggest that consumer sentiment has significant predictive power in forecasting household consumption in Korea, especially for service expenditures.