Let's listen carefully to the signs of the next global recessionRobert J. Shiller
Economists are good at analysing the past but inconsistent at forecasting future events, particularly recessions. This is because recessions aren’t caused merely by concrete changes in the markets. Beliefs and stories passed on by thousands of individuals are significant factors, maybe even the main ones, in determining great shifts in the economy.
his is likely to be the case again, when we face the global next recession. Worries that a great downturn might be imminent seem to have abated, but they still abound. For example, in April the International Monetary Fund reported in its World Economic Outlook that while quite modest growth is likely this year, the world economy was in a “fragile conjuncture".
It is therefore worth asking what actually sets off a real global recession. Most discussions focus on leading indicators - statistics about economic variables that have preceded recessions. While these kinds of correlations can sometimes be useful in forecasting, they provide little understanding of why major changes are taking place. Leading indicators don’t usually address ultimate causes, nor do econometric models that try to predict events.
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In fact, it is instructive to remember that global recessions have usually begun suddenly and been a real surprise to most people. As I have argued in this column and with George A. Akerlof in “Animal Spirits” (Princeton 2009), such events can largely be ascribed ultimately to contagious stories of wide significance.
Basically, global recessions tend to begin when newly-popular narratives reduce individuals’ motivation to spend money. Psychology matters a great deal. The biggest recession of all, the Great Depression, began suddenly with the stock market crash of October 1929, as Christina Romer, the former chairwoman of President Obama’s Council of Economic Advisers, pointed out in a famous paper. She found that, even before 1929 was over, department store sales and automobile registrations had declined, indicating that consumer spending had already dropped sharply. But why?
She found that Economists were alarmed by the descent, and their warnings helped make consumers wary. But let’s not overestimate the importance of these economic forecasts: most people never actually read them. They received their information from other channels.
Back then, immediately after the market crash, church sermons were a powerful influence. Congregations were told that many businesspeople had behaved like gamblers and hucksters. Through these sermons and other word-of-mouth sources, moralizing about the stock market crash spread, affecting the collective psychology.
Frederick Lewis Allen, in the epilogue to their 1931 best seller “Only Yesterday: An Informal History of the 1920s,” wrote that cultural values changed after the crash: people began to dress more modestly, adopting a new formal and religious tone, reviving Victorian sexual taboos. It is reasonable to assume that many of these changes had an economic impact, mainly by discouraging spending.
Similarly in more recent downturns, broad cultural and social changes had widespread effects, too. Since The Second World War, there have been four global recessions according to the International Monetary Fund, which defines such an event quite specifically as negative global per capita economic growth over at least one year. In each case, these recessions lasted only one year, though relatively slow economic growth rates were also an issue in periods surrounding them. The recessions ended in 1975, 1982, 1991 and 2009.
As they had done so with the Great Depression, economists have cited concrete causes for these events. Oil has been named as a fundamental factor in each case, with price spikes blamed on the Yom Kippur war of 1973, the Iran-Iraq War beginning in 1980, the 1990-91 Persian Gulf War and rising energy demand in China and other emerging countries in 2008.
SOCIAL NARRATIVES ARE ALSO SIGNIFICANT
Broader social narratives are sometimes ignored, but they matter, too. Consider the recession of 1975. Along with oil prices, common ways of understanding and describing daily life also changed. The oil crisis was widely said to have signalled the end of an era of abundance. Lower motorway speed limits were imposed to conserve fuel, and cars grew smaller.
Americans were told to lower their home thermostats to 68ºF (20ºC). In large numbers, people began wearing sweatsuits, flannel leg warmers, thermal underwear and long johns. Among all this austerity, the economist E. F. Schumacher’s 1973 best seller “Small Is Beautiful” became a global morality lesson.
Let’s jump to the most recent global recession, the 2009 one. Oil prices, subprime mortgages and the freezing up of the financial system after the collapse of Lehman Brothers were all significant factors. But why did a global recession happen? The transformation of distinct events into a broad global slowdown occurred through a variety of mechanisms. Reports about financial misdoings, the possible collapse of venerable institutions, rising unemployment caused by advanced technology - all of these affected spending psychology.
Where does this leave us now? No single narrative seems to have enough compelling force at the moment to engender a downturn as great as the last one. Many people have been copying from older narratives of risk and vulnerability while trying to understand the current economy. Oil prices have been slumping, not soaring, but there are significant worries about outsourcing, downsizing and globalisation, along with deep concerns about rising inequality, refugee and immigrant flows, and what has been called the secular stagnation of the economy. Political candidates on both left and right have been centring sometimes disruptive narratives on these issues.
We don’t know whether any specific event -say, an unexpected spike in oil prices or a decline in the stock market- will help transform any of the current social stories into truly virulent economic disruptions. We don’t know what is coming or when. But history does tell us that human imagination can spontaneously transform discrete events into world-shaking narratives of unexpected colour and force.