The Self-Fulfilling Prophecy?

Mark Zandi of Moody’s Analytics, who often discusses the economy, recently said something disturbing and fascinating about the possibility of a double-dip recession.  According to Zandi, it could be the only recession that we will ourselves into.   Zandi was talking about gloomy expectations that make people so nervous that in terms of economics, they freeze.  His remarks are a reminder that while we regularly report economic data – unemployment, cost of living, home prices, trade deficits – there are other measures of our economy that are, by definition, subjective.  Do we feel secure?  Do we have confidence in the future to the point where we’re willing to spend money and take risks?

According to Dennis Jacobe of the Gallup Organization, “We’re a lot less confident than we normally are. Three out of four right now will say the economy is getting worse.  And that’s a number that approximates the numbers of late 2008.  I think the American people don’t see the economy that most of us economists and the public policymakers see.  Americans see high unemployment rates and are concerned about losing their job.  They’re concerned about higher food prices and higher energy prices, even though we say that there’s not much inflation.  They’re worried about the housing market.  And then on top of that, they’re worried about things like politics and the confrontational kind of stalemate in D.C. 

“That certainly had an impact according to our numbers,” according to Jacobe.  And what we see happening over the last several weeks is interesting in the sense that the average American, middle and lower income American, has been fairly pessimistic for quite a while with all these things that have been bothering them.  But what we’ve seen happen recently is that things like the confrontation over the debt ceiling bill and on other kinds of things seem to have troubled upper-income Americans.  Now, they’re also affected by what’s happening on Wall Street and what’s happening internationally with the problems in Europe and those kind of things, but when upper-income people also get very pessimistic, that’s when our numbers get up to three-quarters or 80 percent of Americans being worried. 

“There really isn’t.  And, you know, I think that one of the things that’s happening is that we’re not paying enough attention to consumer psychology as opposed to Wall Street and investor psychology.  People all the time talk about how that affects Wall Street and how when Europe has had financial problems, they thought – people thought back to 2008 and the financial crisis and all those kind of things.  But the average American is affected by the same kind of thing.  They saw tremendous financial shock in 2008 and early 2009.  And they saw that in their lives and in terms of not only credit access, but also in terms of their jobs and their job security.  And I think people forget that when a lot of these things happen, like the budget confrontation, that that brings back memories of those days and those troubles.  And that has a major impact on consumer psychology.  So the statement like Zandi made makes a lot of sense in the sense that consumers actually are impacted today differently than, say, in years past,” Jacobe said.

“The trouble is people are so shell-shocked and haven’t really gotten over the recession,” according to Zandi.  “They’re extraordinarily nervous, and when anything goes off script even a little bit they freeze, and that’s where we are right now and why we are so close to recession.”

In discussing the recent Standard & Poor’s downgrade of the United States’ credit rating from AAA to AA+, Zandi believes that there is a logical apprehension that a financial market selloff could feed on itself, doing real economic damage if it drags on.  Wary households might respond by cutting back on spending, and anxious businesses would be even more cautious about investing and hiring.  This could cause a double-dip recession, which would only intensify the nation’s fiscal troubles.  Federal Reserve policymakers are certain to take this into account.  S&P might even downgrade other nations’ sovereign debt, since the U.S. government provides vital support to the entire global financial system. This could increase borrowing costs for homebuyers seeking mortgages and businesses that want to expand.  The impact on lending rates would be small, a few basis points at most.  Financial markets should be able to weather the S&P downgrade, with little lasting economic impact.  “Fundamentally the United States does not deserve a downgrade, because policymakers have made significant strides toward fiscal responsibility.  The debt-ceiling deal was a vital step that doesn’t solve the nation’s problems, but it goes more than halfway,” Zandi said.

One idea that Zandi has to stimulate the economy is to take back unspent dollars from the American Recovery and Reinvestment Act (ARRA) and spend it on projects or on short-term stimuli like food stamps.  This is easier said than done and might create more problems than it fixes.  “It’s meaningful, but it’s not a game-changer,” Zandi said.  “From an economic and political perspective, I’m not sure that would make a lot of sense to do.  A lot of this spending has generated a lot of planning, a lot of environmental designs.  They’re counting on the money. If you’re going to divert it, you’re going to create all kinds of problems for them.”

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