Shiller: Fear of a Double Dip Could Cause One

If you believe the price of a good you consume regularly is going to go up in the future, the best thing to do is to stock up now. If everyone else shares that belief, that will drive the price up, just as you thought. Thus, even if the expectation of an increase in the price was driven by nothing more than speculation and rumor, the expected change in the price will be self-fulfilling. Beliefs about the future will be validated by observable events, and this will tend to reinforce the beliefs (this is one way a bubble could get started, but the point here is simply that expectations can be self-fulfilling).

Robert Shiller says there is a growing belief that the economy will have a double-dip recession, and that this belief may cause the outcome people are worried about:

Fear of a Double Dip Could Cause One, by By Robert J. Shiller, Commentary, NY Times: The risk of a double-dip recession hasn’t abated…, the danger stems from the weakness and vulnerability of confidence — whose decline could bring markets down, further stress balance sheets and cause cuts in consumption, investment and local government expenditures.

Ultimately, the risk resides largely in social psychology. It is the fear of fear itself, of which Franklin D. Roosevelt famously spoke.

From 2007 to 2009, there was widespread concern about the risk of an economic depression, but that scare has been abating. Since mid-2009, it has been

replaced by the milder worry of a double-dip recession… And with that depression scare still fresh in our minds, sensitivity to the possibility of another downturn remains high.

To be sure, many economists doubt that a double-dip recession is in store. … And there have been encouraging factors… But forecasters … may be missing the real worry that many people harbor about the economy.

I use a definition of a double-dip recession that doesn’t emphasize the short term. Instead, I see it as … a recession in which unemployment rises to a high level and then falls at a disappointingly slow rate. Before employment returns to normal, there is a second recession. As long as economic recovery isn’t complete, that’s a double-dip recession, even if there are years between the declines.

Under that definition, there has been only one serious double-dip recession in the last century — and it was serious indeed. It started with the 1929-33 recession, which was followed by a recession in 1937-38. Between those declines, the unemployment rate never moved below 12.2 percent. Those two recessions, four years apart, are now typically lumped together as one event, the Great Depression.

Many negative factors persisted between those dips. High among them was a

widespread sense then that something was amiss with the economy. There was a feeling of uncertainty that discouraged entrepreneurship, lending and spending, and most important, hiring.

We have to deal with a similar — though less extreme — problem today. Many of us are unsettled by images that are preventing a return to normal confidence — images of rioting in Athens, or of baffled American traders during the nearly 10 percent drop in the stock market on May 6. And if the BP oil spill … eventually wreaks havoc on the gulf economy, we may need to add it to the list, too. …

Fostered by mass psychology,… aftershocks could occur in the next year or two. This …  could be … severe. … We need to look at short-run events, like the market reaction to the Greek bailout, as no more than side effects. Slowly moving changes in our animal spirits represent the real risk of a

double-dip recession.

I think the more likely trigger is further economic trouble. We could be hit by big shocks that we are vaguely aware might be a problem but do not yet fully anticipate, or it could be something else unexpected — another big oil shock for political or other reasons would be hard for the recovering economy to absorb. Even more likely is an outbreak of extreme hawkishness causing us to pull back too fast on fiscal stimulus, and to raise interest rates too fast. That is, I think it’s more likely that economic events will drive fear rather than the other way around. That’s not to say that fear doesn’t provide an important negative feedback mechanism, I think it does, but I’m not convinced that psychology is the prime causal mover.

Originally published at Economist’s View and reproduced here with the author’s permission.  

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One Response to "Shiller: Fear of a Double Dip Could Cause One"

  1. Curtis Henson   May 17, 2010 at 10:10 am

    It seems economic events and economic fears are symbiotic. This seems more pronounced in service ecomonies than in product economies..