The interesting paradox of using the term “recession,” over and over again in headlines and on 24-hour news channels, is that it has come to mean so much more than its actual definition.
When people hear the word “recession,” they probably don’t think about the gross domestic product and say: “Oh, our overall GDP shrank by a relatively small amount, mostly because we imported a lot more goods than we exported. But our unemployment is still really low, and this is probably the logical result of easing back on the unprecedented monetary and fiscal stimulus that we just poured into the global market.”
From what I can tell, when people hear or read about recessions, their internal dialogue is more like, “Oh no, our country is in real trouble. I’m in real trouble. Everyone is saying we are, so it must be true. I might lose my job like I did back in 2009, or watch my savings evaporate due to inflation. What’s this about the stock market collapsing? I better be safe and get my investments out so that they aren’t crushed. I can’t afford to have my retirement nest egg go up in flames. We have that one big trip planned for this summer, but after that, it’s time to tighten up the budget a bit because there is clearly a rainy day fast approaching.”
Until fairly recently, economists didn’t like to admit there was a whole lot about market movements that couldn’t be quantified by formulas, graphs and math. Economics majors are a sensitive bunch, and they often have a chip on their shoulders about being considered one of those loosey-goosey social sciences, as opposed to one of those smart, precise, math-based sciences.
Then folks like behavioural economists Daniel Kahneman and Richard Thaler came along to basically say (I’m paraphrasing here), “We just realized, that as a group, human beings are generally really bad about being rational when it comes to numbers and money stuff. We should probably start to look at economics through the lens of how humans actually make decisions, as opposed to how we think they should make decisions if they were human/computer hybrids.”
This behavioural research is probably at the root of why the world’s central banks and governments stood side-by-side in early 2020 and made huge sweeping announcements. Policy makers knew that as much as the actual dollars and cents were going to make a difference in avoiding a complete economic collapse, an unmeasurable aspect of the pandemic financial response was going to be how people felt about the announcements themselves. If people felt the government was really working hard to find solutions, and that everything possible was being done to help them, then they would be a lot more likely to keep spending money, making investments, taking out loans and keeping the economy on its feet.
The truth is we’ll never know just how big a role psychology/behavioural decision-making played in producing the short-lived bear market in early 2020, and the subsequent unprecedented bull market that followed. What we do know is that we did things a lot differently than we did in the past, and that the economy responded far better than most predicted at the beginning of the pandemic.
The potential problem is that the same behavioural principles now apply when things aren’t looking so hot. An influential study on market sentiment by the University of Michigan recently found that consumer sentiment in the USA was the lowest it had been since 2011. In 2011, the overall economy was in massive trouble as people struggled with high unemployment, a cratered housing market, and investor fear around every corner. Contrast that with today’s “help wanted” signs, and you see just what a problem irrationality can be.