Recession: A Self-Fulfilling Prophecy?

The "R" word is getting thrown around a lot lately. In a reaction to the S&P downgrade, stock market volatility, continued housing weakness and a mounting debt load, many fear that the U.S. is on track for another recession. Fear has paralyzed firms, households and politicians alike. Instead of reacting quickly to solve the country’s problems, the uncertainty about a potential recession has quite literally caused slow reactions, and in many cases, no reaction at all. Nicholas Bloom, a professor of economics at Stanford, has written on the paradoxical nature of this dilemma. When people are uncertain, he explains, "they wait and do nothing." Firms do not hire new employees or invest in their business. Consumers do not buy a new car, TV or refurnish their homes. As firms and households resist doing anything and continue to hold back, many analysts worry that the fear of a recession might become self-fulfilling. As the Economist recently pointed out, the Fed ought to play a stabilizing role against these behavioral shifts of firms and households. Instead of leaving the average investor guessing how the Fed will react to market volatility and a deteriorating economic environment, the Fed should establish certainty in times of doubt and restore confidence for the general public before it’s too late.