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Are economic downturns self-fulfilling prophecies?

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Federal Reserve Bank study says atmosphere of uncertainty increased unemployment rate by up to two percentage points.

There are tangible, and often painful, fundamentals that determine the course of the economy -- unemployment, interest rates, housing prices, inflation, industrial production, government debt. But more than anything else, markets are psychology, and an atmosphere of fear and panic among producers and consumers leads to scaling back of purchases, which further exacerbates a downturn.

Over the past few years in particular, there have been plenty of messages of impending doom circulating through the mass media. Like Eeyore, the miserable mule from Winnie-the-Pooh, many pundits ignore any bright spots and flood the airwaves with grim predictions of imminent collapse and despair just around the corner. In an economy heavily tied to consumer confidence, such talk could have far-reaching consequences.

Such downbeat messages may eventually result in a self-fulfilling prophecy, actually translating into job losses. A new analysis by Sylvain Leduc and Zheng Liu, analysts at the Federal Reserve Bank of San Fransisco, says there is a statistically measurable impact from "talking down" the economy. The economists say that the atmosphere of uncertainty in the recent downturn of 2008-2009 added at least one to two percentage points to the unemployment rate:

"During the Great Recession, the increase in uncertainty appears to have been much greater in magnitude.... Our model estimates that uncertainty has pushed up the U.S. unemployment rate by between one and two percentage points since the start of the financial crisis in 2008. To put this in perspective, had there been no increase in uncertainty in the past four years, the unemployment rate would have been closer to 6% or 7% than to the 8% to 9% actually registered."

Policymakers and pundits can't be pollyanish in the face of economic troubles, of course. But the Fed authors suggest that as media channels fill up with dire and downbeat talk, fear levels go up, and people start to lose their jobs. "Heightened uncertainty acts like a decline in aggregate demand because it depresses economic activity and holds down inflation," the Fed economists observe.

Another thing is clear as well: when analysts and pundits put their Eeyore faces on, it doesn't help anybody. What is needed is more discussion and ideas about solutions and disruptive innovation that create opportunities, improve our world, and provide people more control over their economic destiny.

(Thumbnail photo: Joe McKendrick.)

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Joe McKendrick

Contributing Editor

Joe McKendrick is an independent analyst who tracks the impact of information technology on management and markets. He is a co-author of the SOA Manifesto and has written for Forbes, ZDNet and Database Trends & Applications. He holds a degree from Temple University. He is based in Pennsylvania. Follow him on Twitter. Disclosure