Fear of a Double Dip Could Cause One - Commentary by Robert J. Shiller
"Fear of a Double Dip Could Cause One"
By Robert J. Shiller
Published in the New York Times on May 16, 2010
Read the article in its original context on the New York Times website.
The risk of a double-dip recession hasn't abated, even after news of the huge European bailout in response to the Greek debt crisis.
World markets soared initially on the announcement of the nearly $1 trillion rescue plan, and then declined. But as the economist John Maynard Keynes cautioned long ago, such market reactions are basically a ''beauty contest'' — with investors trying to predict the short-term reaction that other investors think still other investors will have.
In other words, don't view these beauty contests as a heartfelt response to a fundamental change in the economy.
In fact, there is still a real risk of a double-dip recession, though it can't be quantified by the statistical models that economists use for forecasts. Instead, 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 Since mid-2009, it has been replaced by the milder worry of a double-dip recession, as a count of Web searches for those terms on Google Insights suggests. 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. One reason may be that we have just had three solid quarters of real growth in the gross domestic product. In the past, when inflation-adjusted G.D.P. has come out of a decline and posted three or four quarters of gains, it has never immediately begun to fall again — at least not since quarterly numbers began to be issued in 1947.
So once G.D.P. gains momentum this way, it generally doesn't stop in its tracks. And there have been encouraging factors — like continuing low interest rates, as well as lower inventory-to-sales ratios and lower growth of stocks of new homes and consumer durables — which suggest that pent-up demand will lead to more sales.
But forecasters who focus on the next four quarters 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 beginning with 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 is not soon contained, and eventually wreaks havoc on the gulf economy, we may need to add it to the list, too.
Consider the May 6 stock market plunge. Though it reversed quickly, it awakened fears of instability, which can change the atmosphere and delay recovery from a recession, possibly even until the next one comes around.
There has been a similar historical example. On Sept. 11, 1986, the Standard & Poor's 500-stock index fell 4.8 percent, then the biggest one-day percentage drop since April 21, 1933. It called public attention back to the Great Depression, even though the decline was reversed within a couple of weeks. The New York Times attributed that one-day drop to ''anxiety, with computer spin,'' referring to trading programs that generated huge sales. Readers were left with ambiguous interpretations of that drop, as they have been in the wake of the recent one-day decline.
That 1986 event stuck in people's minds. It was followed a year later by several aftershocks, then by what is still the biggest one-day drop in history, the 20.5 percent fall in the S.& P. 500 on Oct. 19, 1987.
Fostered by mass psychology, the same kind of aftershocks could occur in the next year or two. This time, in our more delicate economy, the consequences could be more severe.
Since 1989, I have been compiling the Buy-on-Dips Stock Market Confidence Index, now produced by the Yale School of Management. It shows that confidence to buy on market dips has been declining steadily for individual investors since 2009. (The measure is holding steady for institutional investors.) Will individuals continue to support the market, which is now highly priced?
Confidence indexes and other measures of public thinking show gradual trends, often over years, that don't match up precisely with economic events, which are often sudden. 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.
Robert J. Shiller is a professor of economics and finance at Yale and a co-founder and the chief economist of MacroMarkets LLC.