Sunday, January 20, 2008

Psychology is the Joker in Economy's Deck of Cards

From Time Magazine, December 2, 1957 issue:

The uneasy sign in the nation's economic picture is not the statistical droop but the mood. If too many consumers postpone purchases out of worry, shrinkage in sales may bring on a real recession. "Psychology," says Vice President Dr. Arthur A. Smith of Dallas' First National Bank, "is the joker in the economy's deck of cards."

Now I'm not saying I think the U.S. economy is about to go into a recession, but it does seem like there is a certain amount of "recession psychology" going on, and some have suggested that we might be "talking ourselves into a recession." Recessionary fears seem to generate more media attention than maybe more realistic talk of an economic slowdown, which feeds the "recession psychology" (see the increase in "recession" hits above on Google Trends for January).

According to
futures trading on Intrade, there is now about a 71% chance of a U.S. recession in 2008. So let's assume it happens: the U.S. economy goes into a recession this year. How bad will it be and how long will it last? The chart above shows the average length of U.S. recessions going back to 1854, using data from the NBER.

We know this for sure: It could be a lot worse, recessions used to last almost two years during the 1854-1919 period, and 1.5 years in the 1919-1945 period. Since WWII, the average recession lasted 10 months, and the last two recessions (1990-1991 and 2001) lasted only 8 months. With the support of a booming world economy, we could expect a short and shallow 2008 recession, IF if happens. If futures trading is correct, there's a 29% of NOT having a recession, so don't give up hope.

We would have to experience at least 6 months of significant economic downturn to have a recession, and there's no evidence yet that there's even been one month yet of serious decline in the important recession-indicating variables. I'm still saying the U.S. economy is not in recession. But then there's always the joker....


At 1/20/2008 10:31 AM, Anonymous Anonymous said...

But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Federal Reserve Board Governor Ben S. Bernanke, Deflation: Making Sure "It" Doesn't Happen Here

At 1/20/2008 11:35 AM, Anonymous Anonymous said...

Beliefs are a very powerful force on our lives. We assume that homo economonis is a purely rational being and that his/her choices are always objective and rational. Our thoughts and opinions are not only based upon an assessment of the facts available which may be incomplete or imperfect but our emotional response to those facts.

Emotion is part of how we assess information. Fear helps us to perceive when we are in danger.

The traditional western attitude toward emotions is to deny their validity. The idea that our thoughts are purely rational ever is an illusion for neurologically this is simply not possible. The cortical regions of the brain interact with the regions of the emotions. We are human not androids. That gives us the capacity for compassion and love as well as anger, fear, and obstinance when we are confronted with ideas or circumstances which challenge our opinions.

It will be interesting to see whether there is a recession or not because the choices of millions of people do matter. Therefore, perception and belief can become self-fulfilling prophesies.

At 1/20/2008 12:10 PM, Anonymous Anonymous said...

Considering that news stations only care about ratings its no surprise that they continuously dramatize stories. The fear of recession is just the most recent example. The most common abuse I see as a resident of New England is the exaggeration of snow totals for incoming storms.

At 1/20/2008 4:13 PM, Anonymous Anonymous said...

Cramer did nothing good for the psychology of the economy with his now infamous rant in Aug. of 2007.

What was he expecting the Fed to do, come bail out his buddies on Wall St.?

At 1/21/2008 10:28 AM, Blogger Marko said...

I almost hope we get a Dem in the white house - somehow magically the press will decide the economy is going great and everything will be fine! This will help consumer confidence, and we will have another Clinton style decade (seems great, with all the problems papered over and literally exploding after it is over).

Almost hope.


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