Tag Archives: stimulus

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.

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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.

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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