A powerful force holding back the economy today is the mind
While economists and investors have presented plenty of reasons for the underwhelming recovery coming out of the Great Recession, the real problem may be all in their heads.
According to Julian Kozlowski, Laura Veldkamp, and Venky Venkateswaran at New York University, the sluggish rebound from the Great Recession is primarily due to people's skittish attitudes.
"This recession has been more persistent than others because it was perceived as an extremely unlikely event," wrote the economists in a new study. "Observing the crisis in 2008-09 caused agents to re-estimate macro risk. For example, in 2006, no one raised the possibility of financial panic. Today, the question of whether the financial crisis might repeat itself arises frequently and option prices continue to reflect heightened tail risk (defined as the probability of large adverse shocks)."
To the researchers, much of the lagging economic growth is because Americans were so freaked out by the Great Recession, they've been bracing for the next hit instead of jumping into a serious recovery.
According to the study, the last downturn has had a different effect than any other recession of the past 50 years.
The reason, said the study, is that the level of shock produced by the Great Recession changed the game for investors.
"Extreme events, like the recent crisis, are rare and therefore, lead to significant changes in beliefs and long-run outcomes," said the researchers.
"Milder downturns, on the other hand, show up relatively more frequently in the agents' data set and therefore, have only small effects. In other words, while all changes to beliefs are permanent, deeper recessions induce larger, permanent belief changes."
In order to observe how the belief changes impacted the economy, the researchers created a model which evaluated those changes over time and coordinated it with economic output in post-WWII America. They were then able to model out the effect of various economic shocks on investors' appetite for risk and how that changed subsequent growth.
For a recent comparison, the study compared economic agents' reactions to the milder 2001 recession against the deeper 2008 recession.
"With the 2008-09 shock, however, the change in beliefs (and through them, on aggregates) is quite dramatic, leading to very different long run outcomes." said the study. "This is not really about the size of the shock per se, but the effect it has on beliefs. If large shocks had been observed frequently, it could also have transitory effects."
These belief shocks are wide-ranging. The willingness for firms to hire new employees, companies willingness to take on new debt, and national GDP growth are all depressed over the long-term due to the sudden downturn.
In the end, say the researchers, the timidness of economic actors may be holding back the economy from fulfilling its full potential.