Tag Archives: consumers

The Economy as a Confidence Game

It’s all about confidence.

The economy, that is. So much of what determines whether an economy grows or shrinks is a result of what people expect will happen in the future. If consumers feel good about the future – if they’re not worried about losing their jobs, or believe they’re going to find a job, or get a raise or get promoted – then they’re likely to spend more money.

And if consumers spend more money, companies make more money. And if companies expect consumers to spend more money, then companies will spend more money expanding and building more stores and offices and factories.

And if companies spend more expanding, it creates more jobs and give consumers more money to spend.

And so on, and so on, and so on. It’s all a virtuous circle that rebounds on itself to reinforce positive feelings and growth all around. Or a vicious cycle, when sentiment goes sour.

This is why there are surveys of consumers and purchasing managers and corporate executives, to find out how they’re feeling about the future. Feelings and perceptions matter.

***

So what do you do to get the confidence game rolling? How do you take an economy that’s down on its luck and inject enthusiasm and warm economic fuzzies?

For starters, you talk a good game. You tell people things are going to get better, but it’s going to take time. You be honest, but reassuring. This is why policymakers since time immemorial have tried to talk things up with the economy was down. Confidence is important, and if leaders don’t have it, consumers and companies won’t either.

But words aren’t going to do much by themselves, of course. Herbert Hoover spent much of 1929, 1930, and 1931 telling people that good times were just around the corner, and we all know how much good that did. You’ve got to follow the words with action.

The standard economic prescription is for the federal government to step in with fiscal and monetary stimulus to compensate for the lost spending by consumers and companies. Government money has a multiplied effect on an economy, as it circulates around. As people see things start to get better, confidence will gradually improve as well. Eventually that self-reinforcing virtuous circle can kick in, and the economy can start to grow steadily.

***

But this takes time, and lots of things can derail a recovery from a severe economic downturn. Economic turbulence in other countries not only decreases demand for your country’s exports, but it also works against the confidence of companies and consumers. Political instability in other countries, oil price shocks, droughts in agricultural regions – all of these can complicate things further.

What don’t you do? What should you absolutely avoid, so you don’t wreck a fragile economic recovery? You don’t create gridlock in Washington, sending the message that the federal government is not going to do anything to help the economy. You don’t create a no-win fiscal cliff scenario with threatened spending cuts and tax increases that would devastate the economy. You don’t play games with the full faith and credit of the United States with a manufactured “debt ceiling”.

I’m not saying that economics is all an illusion, that downturns are all in our minds, that the Great Recession is just some giant psychosomatic economic illness. Recessions are real, and the most recent one was unusually severe.

But humans are emotional creatures, and perceptions matter to us.

We need for the federal government – and Congress in particular – to get its collective head on straight and start leading instead of obstructing. When Congress starts showing that it wants to be part of the solution rather than the problem, consumers and companies will start showing confidence. And when they do, we can get the economic confidence game rolling.

Related Posts: Why Deficit Spending During Recessions is Good

Consumer Debt Continues to Decline

Consumer debt continues to decrease. Households seem to be getting their finances in order, which eventually should be good news for the economy. With less debt hanging over their heads, consumers will be more willing to open their wallets, which can help stimulate economic growth and create more jobs.

The ratio now is below 1.1 after having been over 1.3 in early 2008. However, by historic standards, the ratio is still high. Up until 2001, it was below 1.0, and before 1986 it was less than 0.8.

Consumer Confidence Up 9 Points in September

Consumer Confidence was up 9 points in September, increasing from 61.3 in August to 70.3, according to the Conference Board. This is a positive sign for the economy, indicating that consumers are feeling more optimistic about their current employment and financial situations, suggesting that they will be more likely to spend money in the future.

Consumers also were more optimistic about the near-term future, with more than 18 percent expecting things to improve over the next six months. Less than 14 percent expect business conditions to worsen during that period.

Here’s a graph of the Conference Board’s Consumer Confidence index from 2000 through September 2012. The index fell substantially from a peak of 111.9 in July 2007, down to 25.3 in February 2009. Since then it has gradually trended upward, except for a downward spike in 2011.

Credit Cards and Irrationality – Protecting Us from Our Brains

Human beings are rational.

It’s a basic assumption of economics. Humans are rational beings. Homo economici. We don’t intentionally try to make ourselves worse off.

In his book How We Decide, Jonah Lehrer cites a wide range of psychological, behavioral, and economic research to argue that emotions guide many of our economic decisions. He makes the case that emotions are not just irrational feelings of love and hate, but instead are the result of how the human brain is wired.

And these emotions can cause us to do things that are bad for us.

Take credit cards. Buying things with cash activates a part of the brain called the insula. We actually feel a sort of subconscious pain – emotional discomfort – when we spend cash, since we’re physically giving up something.

When we pay by credit cards rather, however, our brains don’t feel the same sense of loss. Brain scans show that paying with credit cards reduces activity in the insula, causing us to feel less discomfort about the purchase. We literally feel it costs less with credit than with cash.

Basic economic theory says there shouldn’t be a difference between paying by cash or by credit card. Both involve the same loss, so we should view both the same. If anything we should feel worse about paying by credit card, since that could result in having to pay interest or late fees, .

But that’s not how the brain sees it. Which is why so many otherwise rational people get in over their heads with credit cards.

I remember when I was in college and got my first credit cards. Even as an arguably intelligent and sensible person, I still fell into the trap and over-extended myself. Fortunately for me, I got a steady job and eventually was able to pay off my debt. But it took many years to do so. If anything had gone wrong before I did – if I’d gotten sick or had lost my job – I could easily have fallen into a vicious cycle of debt dependent. And if that had happened, I doubt that I would now be here writing about the dangers of credit card debt.

Credit card companies know about the brain’s weaknesses and use every trick they can – low introductory rates, fine print, hidden fees – to take advantage of them. And they’re really good at it. So good in fact that millions of Americans get into credit card trouble every year.

It’s easy to say that this is their problem. They got themselves into trouble. Let them get themselves out of it. And there’s some truth to that. Society can’t take responsibility for every bad decision. Choices have consequences. People need to learn that and take responsibility for their own actions.

But a good case can be made for trying to prevent the worst abuses, particularly since neuroscience research – actual brain scans – tells us that it is due to the very way the human brain works.

From a self-interest perspective, having so many people getting into credit crises also isn’t good for society as a whole. People who get in over their heads aren’t able to pay their bills, are likely to have psychological problems, will have more trouble holding on to their jobs, and will have difficulty caring for their children. This makes it more likely that their kids will grow up to have problems in life as well, thus perpetuating the problem.

Fortunately, the U.S. government has been taking steps to curb the worst credit card abuses. The recently-establish Consumer Finance Protection Bureau has taken an aggressive stand against credit card companies that use unethical means to prey on consumers.

I’ve always been opposed to unnecessary government regulation and involvement in the economy. Government regulation imposes a burden on businesses and on society, unless there’s a good and overarching need for it.

In this case there is. There are situations where people do need to be protected from themselves, and this is one of them.

Sometimes people need to be protected from the flaws in our own brains.

It’s only rational.