The Downturn: Is It Really Just an Attitude Problem?

There’s a new fear on the economic horizon: Americans may be talking themselves into a recession.

No one knows precisely why, but consumers are becoming more pessimistic every day. The University of Michigan index of consumer sentiment, a confidence barometer now included in the government’s index of leading economic indicators, fell 25% from April to August.

And the Conference Board’s index of consumer confidence plunged from 85.6 in September to 61.3 in October, its lowest level since the 1982 recession. A year ago, the confidence index was nearly twice its October level.

What worries analysts most is that the increasing consumer pessimism over the economy will spawn a sharp cut in spending that will eventually become a self-fulfilling prophecy and accelerate the onset of the long-awaited recession.

“What we are concerned about is that consumers will hear reports that a recession is coming and then get more scared and cut back on spending,” says David Kelly, a specialist in consumer research at DRI-McGraw Hill, an economic forecasting firm in Lexington, Mass. “And that makes a recession happen.”

Stephen S. Roach, a senior economist at Morgan Stanley who specializes in consumer research, agrees.

“Since World War II, we haven’t had a recession in this country that was brought on by fear, but I think there is a risk of that happening now,” Roach says. “Fear-mongering can get out of control.”

Widespread predictions in the media during the past several months that the economy may be heading into a recession may be playing a part in making consumers more pessimistic.

On Sunday, the Los Angeles Times Poll found that California residents are bracing for a recession by trimming spending plans for new cars, vacations, Christmas gifts and restaurant meals--a behavior pattern that analysts say could intensify the slump.

But most analysts point instead to deeper factors, including the crisis in the Persian Gulf and the massive selloff in the stock market. The haggling in Washington over how to cut the budget deficit also sapped public confidence.

Consumers were already lowering their expectations because of the drop in real estate values and the worsening plight of banks and savings and loans.

“Things like the Persian Gulf can make people behave differently,” says Lyle Gramley, chief economist at the Mortgage Bankers Assn. in Washington.

Gramley’s fear is that with so many negative outside events hitting at once, consumers, whose spending accounts for roughly two-thirds of the overall economy, probably will cut back sharply--just before the crucial Christmas selling season.

Although third-quarter consumer spending figures, due out next week, probably will show strong gains from earlier in the year, much of that strength stemmed from spending in June and July, before the Iraqi invasion of Kuwait on Aug. 2.

And, although car sales have shown surprising strength, much of that has been attributable to sales incentives that have steeply discounted sticker prices.

But most economists now predict that consumer spending will finally tail off in the fourth quarter--possibly during the Christmas season--when spending patterns will more fully reflect the impact of the oil shock.

If that happens, the pessimism could spread quickly throughout the economy.

“I think people know what is happening in their areas,” adds Stephen Axilrod, an economist with Nikko Securities in New York.

“They observe what housing prices are like, they look at what is happening to their mutual fund and then they start to cut back. And that can have an accelerating effect. That cutback could get you a strong negative reaction in the economy.”

To be sure, mass psychology is no substitute for basic economics, and many economists caution that consumer attitudes cannot transform an otherwise healthy economy into a sick one.

Gramley recalls how the heart attack that then-President Dwight D. Eisenhower suffered in 1955--and his subsequent hospitalization--sparked widespread concern about the business outlook. In the end, however, that pessimism was not enough to offset the economic boom at the time.

More recently, the October, 1987, stock market crash led to predictions of a deep recession, but the rest of the economy was stable enough to withstand the sharp decline in Wall Street’s wealth.

It is only when the economy is already on the ropes that waning consumer confidence can deliver a severe blow, analysts say.

“There are very real things going wrong with the American economy and that is why consumers are worried,” says Barry Bosworth, a Brookings Institution economist. “I don’t think consumer expectations are easily manipulated. I think people are responding to very real events.”

Still, other economists point out that attitudes can have a real impact when the economy is teetering on the edge.

They say that the “wealth effect” can prompt consumers to cut their spending by about a nickel for every dollar of decline in the value of their homes and other assets--even if their annual incomes are not reduced.

“But it only works when you are close to a recession already,” observes David Wyss, an economist at DRI-McGraw Hill.

Still, some analysts believe that consumer attitudes could improve just as rapidly as they have deteriorated this fall, if world events change once again.

An Iraqi withdrawal from Kuwait, for instance, could bring both lower oil prices and a dramatic rebound in attitudes among consumers. Many Americans, after all, are not happy about having to cut back and may look for any excuse to spend once more.

“There is a dilemma among consumers,” Kelly says. “They are worried about the economy, yet they also have a desire to maintain the living standards they have enjoyed in the last few years.”