February 26, 2008 / 8:41 PM / 12 years ago

Fear of U.S. recession could help drive one

WASHINGTON (Reuters) - Fear among U.S. consumers and businesses that the world’s richest economy could go into a recession, or may already be in one, could help push the economy over the edge and bring on an even deeper, longer downturn.

A pedestrian makes her way through a snowfall in New York, February 22, 2008. REUTERS/Keith Bedford

In the final three months of 2007, the economy screeched to a near standstill, dragged down by what many economists say is the worst housing slump since the Great Depression.

As a result, talk of recession has been on the rise among Main Street people as well as economists, the media and a number of high-profile analysts, including former Federal Reserve Chairman Alan Greenspan.

With the housing market showing no sign of reaching bottom and mortgage-related losses mounting at Wall Street firms, many experts wonder if all the talk may add to the tendency of people to dampen their economic activity and spend less.

In economic circles, the concept of self-fulfilling prophecies is not new. It is a facet of what classical economist John Maynard Keynes called the “animal spirits” that dictate consumer behavior and drives economies.

Already there are signs of consumers getting gloomy. The Conference Board said consumer confidence slumped to its lowest level in five years. A Reuters/Zogby poll released last week that found most Americans now expect a recession in the next year.

Consumer caution comes at a tough time for an economy already lumbering under the weight of a housing downturn and a critical time for the government’s plan to boost spending.

Many Americans will soon have extra money in their pockets from tax rebate checks that are a part of an economic stimulus package President George W. Bush recently signed into law.

The $168 billion plan aims to stimulate the consumer spending that accounts for two-thirds of the U.S. economy’s output.

But consumer anxiety could undercut the hoped-for effect. The Reuters-Zogby poll found nearly half plan to use their tax rebates to pay down debt or pad savings.

“I suspect we are entering a period where consumers are much more sensitive that there is a need to save,” said Michael Prebenda, global head of HSBC Direct, which released a study earlier this month showing that four out of five Americans plan to increase the amount they save this year.

“Tough economic times are changing the way Americans manage their finances,” he said.

In one measure of how recession talk might be entering the mainstream, a news search of the word “recession” on Web search engine Google generates more than 97,000 news story links, versus the 300,000 for the economy as a whole. (For comparison, Britney Spears generates 22,000.)

“The power of the pen means that as people read the things that we write, they are forming an impression and their impressions can become a self-fulfilling prophecy,” said Chicago-based economic consultant Carl Tannenbaum.

“While a self-fulfilling prophecy isn’t going to be a cause for the recession, I think it can make it worse and I think it very likely will,” said Stephanie Madon, an associate professor of psychology at Iowa State University who has studied self-fulfilling prophecy behavior.


“One of the things we know people do is that they tend to seek out information that they believe is already true,” Madon said.

Some experts say a collapse in “animal spirits” helped bring on the last recession in 2001 as businesses, worried about what the future would bring, cut back sharply on their investments.

Lila Rajiva, co-author of the book “Mobs, Messiahs, and Markets,” says a herd mentality can drive the economy to unsustainable heights and then exacerbate the lows.

“I think we are already in a recession and it’s the result of a mob mentality in the sense that all kinds of bubbles are driven by a crowd acting like a crowd,” she said.

While Keynes applied his “animal spirits” to business behavior, Harvard professor Jeffrey Frankel, a member of the private-sector panel that dates U.S. recessions, says the idea can be applied to consumers as well.

“There can be an element of self-fulfilling prophecy,” said Frankel. He said, in particular, it could be a channel through which economic downturns are transmitted from one country to another as consumers elsewhere begin to worry.

Other members of the business-cycle dating committee at the National Bureau of Economic Research, who have yet to determine if the U.S. economy has tumbled into recession, play down the role of fear in the latest consumer-spending slowdown. A recession is commonly defined as two consecutive quarters in which the economy contracts.

“A decline in consumption might just be a return to normal, rather than self-fulfilling collapse,” said Robert Hall, the

Stanford University professor who chairs the panel. He said softer spending was likely inevitable because consumers had saved so little in recent years.

Another panel member, Northwestern University professor Robert Gordon, also said the current slowdown had roots that lay somewhere other than in the human psyche.

“The currently evolving possible-recession (not clear yet) is being led by a huge decline in residential construction, which is clearly spreading to a credit crunch influencing other types of businesses and consumer spending,” he said in an e-mail.

Reporting By Joanne Morrison; Editing by Richard Satran

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