The Psychology of a Downturn

Recessions may originate in the financial markets, but their effects hit closer to home.

When times are good it’s easy to forget the bad. But with an uneven economic recovery that still hasn’t materialized for many, this time the worry over recession feels more immediate for many American families. In the run up of the housing bubble in the early 2000s it was hard to imagine that the reverse would be equally dark in the other direction. And the public was right to be skeptical, because if anything the bad times were even darker than they could have imagined.

The Great Recession was the worst downtown since the Great Depression, but more than that it was a time when Americans lost faith in the system. When even the President looked into the camera like a deer in the headlights, and everyone declared capitalism as we knew it dead. All the assurances of Wall Street and the economists gave way to glassy stares and fear. People lined up outside of major banks like Washington Mutual despite the assurances of its FDIC backing. It was a modern bank run in the era of Facebook, not FDR, and despite all logical assurances people couldn’t resist the emotional tug to join the stampede.

When the economy shifts the psychological takes over. It’s always there of course, but during the good times that pressure is channeled into being a model consumer and takes the form of granite counter tops and the more acceptable act of keeping up with the Joneses. During the bad times, it creates the kind of moral hazard that leads your neighbor to stop sending in the mortgage check, calculating it will take months or years for the bank to process the foreclosure.

During the last recession these psychological shifts were dramatic. Consumers understandably shut their wallets and curtailed spending, but the effects of the belt tightening also manifested in other ways. In 2008 fashion soured on colorful prints, with dark palettes and severe silhouettes “mirroring the economy’s dour mood.” In 2009 there was a glut of lobster on the market, but despite its relative cheapness no appetite to eat it. This distaste for excess in leaner times human beings may explain why even wealthy consumers who were still personally well off cut their spending in response to the economic news, creating additional economic pressure since the top 10% of incomes account for nearly half of all spending.

Which is why news that the rich were cutting their spending last fall raised concerns. Given their outsize economic influence, the fact that the ultra wealthy expect a recession in 2020 might be enough to trigger one. Their spending power has become so outsize that their wealth effects on consumption can account for significant swings in the boom bust cycle. In other words, income inequality has left us more vulnerable than ever to the psychology of a downturn.