Can We Expect More Than One Pandemic?

Popular Economics Weekly

Wrightson/ICAP

Yes, says behavioral economist Robert Shiller, who won his Nobel prize for the study of human behavior in financial markets. Why? Financial market investors are panicking because of the COVID-19 pandemic, for starters, which could affect the general public’s financial behavior as well, and so wreak even more damage to crashing financial markets.

“We are feeling the anxiety effects of not one pandemic but two,” said Dr. Shiller in a recent Project-Syndicate article. “First, there is the COVID-19 pandemic, which makes us anxious because we, or people we love, anywhere in the world, might soon become gravely ill and even die. And, second, there is a pandemic of anxiety about the economic consequences of the first.”

The first indication of a looming loss of confidence in the economy and jobs is showing up in consumer sentiment surveys, per Wrightson’s above graph. The University of Michigan’s consumer sentiment index fell by 12 percent in March. 
The Conference Board’s confidence survey fell as well.

“Consumer confidence declined sharply in March due to a deterioration in the short-term outlook,” said Lynn Franco, Senior Director of Economic Indicators at The Conference Board. “The Present Situation Index remained relatively strong, reflective of an economy that was on solid footing, and prior to the recent surge in unemployment claims. However, the intensification of COVID-19 and extreme volatility in the financial markets have increased uncertainty about the outlook for the economy and jobs. March’s decline in confidence is more in line with a severe contraction – rather than a temporary shock – and further declines are sure to follow.”

Dr. Shiller knows a lot about human behavior, and the irrational behavior of financial market investors. He wrote about irrational exuberance in his best-seller of that name in 2000, just as the Dot-com bubble burst from overinvestment building the digital infrastructure (remember all those fiber-optic cable networks being laid?).

And the Great Recession was caused by the busted housing bubble—due to home buyers bidding up housing prices to stratospheric heights because of the popular thought that housing prices could never decline—another example of irrational exuberance.

Now what about its opposite—irrational pessimism, or a contagion of fear that stock prices have no visible bottom; or a cure or vaccine will not be found in time to save many companies from bankruptcies, due to a prolongation of social isolation and business shutdowns?

“The effects financial anxiety has on the stock market may be mediated by a phenomenon that psychologist Paul Slovic of the University of Oregon and his colleagues call the “affect heuristic,” said Shiller. “When people are emotionally upset because of a tragic event, they react with fear even in circumstances where there is no reason to fear.”

Dr. Shiller’s research has found that people tend to react to rumor, word-of-mouth, or popular media stories rather than actual facts.

In a joint paper with William Goetzmann and Dasol Kim, for example, Shiller found that people living within 30 miles of the epicenter of a substantial earthquake significantly raise their expectation that there could be a 1929- or 1987-size stock market crash.

Similar fears may have caused the plunge in market asset values today, where interest rates and Treasury bond yields have plunged to historic lows as investors flee to save haven investments in order to preserve their cash.

While many Americans might have faith in upcoming cures for COVID-19, they might not have such faith in a restoration of the economy and jobs. It took years for markets to recover from the Great Recession, even with the Fed holding their rates to almost zero.

I maintain that we will need some form of a New Deal, or even Green New Deal—prolonged market interventions by government in a word—to reassure Americans and the rest of the world that the second, anxiety pandemic can be controlled as well.

Harlan Green © 2020

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