Friday, May 25, 2012

Could Obama v. Romney Debate Push us Back Into Recession?

With the recovery from the deepest economic downturn since the Great Depression still very much a work in progress, it is natural that the presidential candidates tout their own economic credentials and attack their opponents’. The only problem is that the overheated rhetoric might itself be bad for the economy.
Recall that recessions and recoveries are dependent on what Keynes called “animal spirits,” which can provoke waves of self-fulfilling optimism or pessimism. For example, in Keynes’s time, if a bank failed and depositors thought it an isolated event, it was.  Other banks would do just fine. If depositors thought the failure signaled  systemic failure, though, they’d want to withdraw their deposits and the resulting bank run sank even the most prudent financial institution.  Pessimism, too, is self-fulfilling. (Deposit insurance was put in place in the 1930s to prevent bank runs, by guaranteeing most deposits, and that, combined with the Glass-Steagall regulations that prevented banks from gambling with their insured deposits, worked well until the regulations were repealed and bankers went wild.)
Recessions and recoveries also depend on confidence.  If households and businesses believed that the economy was on track for solid growth, firms would invest and hire more and consumers would be willing to spend more, unburdened by the fear of imminent job loss. The prospect of higher interest rates would encourage more people to buy homes, cars, or other big-ticket items.  The boost in hiring and spending would reinforce households’ and firms’ expectations and they’d ramp up economic activity even more.  State and local tax revenues would surge, and governments would start hiring back some of the workers they have had to lay off in the past couple of years, and the newly employed workers would spend more money.  Optimism would be self-fulfilling.
But pessimism is also self-reinforcing. If businesses and consumers are pessimistic or highly uncertain, they’re less likely to hire, invest, and spend, which means that more firms shut down or lay off workers, which boost unemployment and further depresses confidence.  If most Americans were convinced we were headed back into recession, we would be.
Which brings me to the election campaign… President Obama and Governor Romney are both doing a fabulous job of explaining why the other would be incompetent to manage the economy.  Anyone paying attention who believes the rhetoric of either candidate would be forgiven for guessing that economic disaster is a 50-50 proposition (given that the polls are about evenly split). Given how salient negative political messages seem to be, independents might place the odds even higher.  And this will only get worse as we get nearer the election and candidates and super-PACs inundate us with attack ads focusing on the economy.
This is certainly not a recipe for appeasing the animal spirits.  That said, I have no idea how important this insight is.  Only a handful of presidential elections have occurred during recessions since World War II and none has been as bad as this one.  In at least some prior elections, friendly legislatures have been more inclined to enact policies to mitigate the effect of the recession, while the House and a disabling minority in the Senate seem bent on undermining this president’s programs.
If it’s true that election rhetoric hurts the economy and if the conventional wisdom is right that the economy will decide the election, then this is good for Mitt Romney. Let’s hope President Obama is wrong about what that would mean for the economy.
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