« Paul Krugman: Banks Gone Wild | Main | links for 2007-11-24 »

Friday, November 23, 2007

"Ultimately, Consumer and Business Confidence are Mostly Irrational"

Robert Shiller says images that ought to remind us of troublesome past episodes in financial and energy markets are largely absent today - we don't see long lines at gas pumps, financiers leaping from buildings, etc. - and this explains why consumer and business confidence have not, as of yet, declined substantially. But should those images begin to change, watch out:

Markets ail, yet people irrationally exuberant, by Robert Shiller, Project Syndicate: The world's oil and stock markets have been plunged into turmoil in recent months. Yet consumer confidence, capital expenditure, and hiring have yet to take a sharp hit. Why?

Ultimately, consumer and business confidence are mostly irrational.

The psychology of the markets is dominated by the public images that we have in mind from day to day, and that forms the basis of our imaginations and of the stories we tell each other.

Popular images of past disasters are part of our folklore, often buried in the dim reaches of our memory, but re-emerging to trouble us from time to time.

Like traditional myths, such graphic, shared images embody fears that are deeply entrenched in our psyche. The images that have accompanied past episodes of market turmoil are largely absent today.

Consider the oil crisis that began in November 1973, resulting in a world stock market crash and a sharp world recession. Vivid images have stuck in people's minds from that episode: long lines of cars at gas stations, people riding bicycles to work, gasless Sundays and other rationing schemes.

Today, the real price of oil is nearly twice as high as it was at the peak of that crisis, but we have seen nothing like the images from 1973-75. Mostly we are not even reminded of them. So our confidence is not shaken, yet.

Just before the October 19, 1987, stock market crash, the biggest one-day drop in history, the image on people's minds was the crash of 1929. Indeed, the Wall Street Journal ran a story about it on the morning of the 1987 crash. ...

Images of 1929 - of financiers leaping from buildings, unemployed men sleeping on park benches, long lines at soup kitchens, and impoverished boys selling apples on the street - are not on our minds now.

The 1929 crash just does not seem relevant to most people today, probably because we survived the 1987 and 2000 crashes with few ill effects, while 1929 seems not only the distant past, but another world. ...

The images that are uppermost in our minds are of a housing crisis. We imagine residential streets with one "for sale" sign after another. Worse, there are images of foreclosures, of families being evicted from their homes, their furniture and belongings on the street.

If home prices continue to decline in the United States and possibly elsewhere, there could be many more vivid images. You may yet be presented with the image of your child's playmate moving away because his parents were thrown out in a foreclosure. You may see a house down the street trashed by an angry owner who was foreclosed.

Such images become part of your sense of reality, and could disturb your sense of confidence and reduce your willingness to spend and support the economy. Could such changes in psychology be big enough to tip us into a world recession?

While it is far from clear that they will, it is a possibility. Psychology need only change enough to bring about a drop in consumption or investment growth of a percentage point or so of world GDP, and market repercussions can do the rest.

    Posted by on Friday, November 23, 2007 at 02:07 PM in Economics, Financial System, Housing | Permalink  TrackBack (0)  Comments (13)


    TrackBack URL for this entry:

    Listed below are links to weblogs that reference "Ultimately, Consumer and Business Confidence are Mostly Irrational":


    Feed You can follow this conversation by subscribing to the comment feed for this post.