The moody economy

Americans' optimism about the economy incredibly spikes after Bin Laden's death

Sometimes I think of the economy as someone's mood, multiplied by millions. Feel good today? Then the economy will probably do well. Feel down? Then you'll probably postpone that weekend getaway, and the economy is going to do badly. A self-fulfilling prophecy, in essence.

The latest confirmation of this came in this month’s Gallup report, which shows that Americans' optimism about the economy jolted upward in the wake of Osama's death. Now, one may think that people are going to feel safer flying or going out now that Osama is dead, but the fact remains that the American economy and Bin Laden's death are hardly related at all. The Gallup piece mentions itself a "halo effect" as responsible for this upward movement of the economic sentiment.

The trouble is that this halo effect, when the economy may be going bad, is responsible for many unnecessary lay-offs, foreclosures and other horrible things. Some economists even think that there was a positive economic effect in Italy and Spain after the two nations won the Soccer World Cup, in 2006 and 2010 respectively. In essence the economy, something that you usually think of as an external force that you can only react to (much like the weather), is in fact something that you create.

Now, there are a few problems here.

First, economists generally study no or little psychology, and use mostly coldly rational models to predict how the economy will fare. A lot depends on their predictions. Maybe they could use a little more psychology?

Second, in economics the role of information is fundamental. Perfect information (i.e. information that is complete and equally available to everyone) is necessary for perfectly functioning markets. But information is also comprised of expectations (e.g. "Economic optimism improves on job data"), which are in turn influenced by information. In other words, this is a loop, and I am not sure how this loop is dealt with by economic models. Something tells me that economists (who, remember, are generally wary of “soft” and “impalpable” things such as psychology and feelings) simply ignore this fundamental mechanism.

Finally, the role of the media. Say one year you go out for drinks 100 times. The year after you go out 98 times. You would hardly notice the difference (minus 2%). But if the economy was forecast to shrink by 2%, that would make dramatic headline news for weeks in a row. The public would be banged on the head with doomsday reports. Guess what happens. People get scared and start buying less. Companies cut back. The snowball starts rolling downhill. Basically, a true recession of 2% is turned into a much larger slump (4%? 6%? You name it) by expectations which are made stronger or weaker by the amount of media hype. And the media seems to be relishing this volume-boosting role. But this hype causes a lot of unnecessary pain, and it is far from being an objective description of reality. It is just a way to create a new reality, one where more journalists have jobs, but where everybody else is worse off.