Stuck in Neutral? Reset the Mood - Commentary by Robert J. Shiller
“Stuck in Neutral? Reset the Mood”
By Robert J. Shiller
Published in the New York Times on January 31, 2010
Read the article in its original context on the New York Times website
The United States and other advanced economies may be facing a long, slow period of disappointing growth.
That is a widespread concern, as recent polls demonstrate. A USA Today/Gallup poll, for example, found this month that about two-thirds of Americans say they think that economic recovery won’t start for two more years, while 28 percent say it won’t begin for at least five years.
Among students of history, there are fears that we will suffer the type of chronic economic malaise that afflicted the world after the 1929 stock market crash, or that weakened Japan after the puncturing of twin stock and housing market bubbles around 1990. The post-1929 depression did not end for about a decade, and Japan has still not emerged from its post-1990 slowdown.
The fears themselves are an integral part of the problem. Economists have a tendency to assume that everyone’s behavior is rational. But post-boom pessimism is a factor driving the economy, and it is likely to be associated with attitudes that may be enduring.
In reality, business recessions are caused by a curious mix of rational and irrational behavior. Negative feedback cycles, in which pessimism inhibits economic activity, are hard to stop and can stretch the financial system past its breaking point.
Today, banks are not making an abundance of new loans, and this is clearly linked to the decline in confidence. In an October survey, the Federal Reserve asked banks why they weren’t lending.
Respondents said the reasons were a reduced tolerance for risk, followed by a less favorable or more uncertain economic outlook and a worsening of industry-specific problems.
If banks do not have the confidence to make loans, business cannot proceed, and the lack of confidence becomes a self-fulfilling prophecy. This was recognized as a major problem during the Great Depression. Reflecting a common view of the time, a 1933 article by John Pell in the North American Review described this cycle as “self-evident.”
Mr. Pell gave the example of a start-up company that had a new idea for manufacturing a windshield wiper. The economy needed such ventures multiplied “a few thousandfold,” he said, to get rolling again. But if you tried to start such a venture, “bankers would tell you that investors, on whom you must depend for your capital, were in no mood to tie up their funds, in an unliquid security, and were only interested in buying liquid, marketable, securities.”
Were the investors described by Mr. Pell rational? That is an unanswerable, for no one can prove what the rational expectation should have been. But we do know that there was a negative “mood,” as he called it, that must have influenced their thinking.
Today, after the speculative bubbles in the housing market, we are leaving a time of irrational exuberance when many people and financial institutions bet their future on speculative trading, not on genuine economic contribution. Speculation is a healthy capitalist activity, but there is a problem if it becomes a national obsession, as it did in the boom before this crisis. President Obama’s proposed “Volcker Rule,” which seeks to limit bank risk-taking, may be seen as a response to widespread disillusionment with excessive speculation.
The present mood, though, needs to be put into a longer historical context. After World War II, there was rapid growth in labor productivity until sometime around the early 1970s. But then there was a major break, roughly coinciding with three events of 1973-74: the oil crisis, a huge stock market tumble and the first significant depression scare since the Great Depression itself.
According to the Bureau of Labor Statistics, annual growth of business output per labor hour averaged 3.2 percent from 1948 to 1973, but only 1.9 percent from 1973 to 2008.
Ever since the long-term productivity slowdown became visible, the economist Samuel Bowles, now at the Santa Fe Institute, has said that its causes are to be found as much in the loss of “hearts and minds” of workers and investors as in technology.
This month at Yale, in lectures titled “Machiavelli’s Mistake,” he spoke of the error of thinking that a high-performance economy could be based on self-interest alone. And he warned of the overuse of incentives that appeal to individual gain.
The speculative boom periods that ended a few years ago carried us into such overuse, and today’s malaise is partly a result of our disorientation from that period.
In their coming book, “Identity Economics,” the economists George Akerlof of the University of California, Berkeley, and Rachel Kranton of the University of Maryland argue that an economy works well when people personally identify with it, so that their self-esteem is tied up with its activities.
The authors emphasize this example from the military: Well-functioning fighting units have never been built on pay-for-service alone. People will sacrifice their lives if they believe in the cause and in one another.
In most civilian fields, job satisfaction may not be a life-or-death matter, but a relatively uninterested, insecure work force is unlikely to bring about a vigorous recovery.
Solutions for the economy must address not only the structural instability of our financial institutions, but also these problems in the hearts and minds of workers and investors — problems that may otherwise persist for many years.
Robert J. Shiller is professor of economics and finance at Yale and co-founder and chief economist of MacroMarkets LLC.