Trajectory

As most people who know a little about economics understand, psychology is very important. I'm not much for the if our leaders talk with confidence in the economy it will improve theory. However, I am a big believer in deflationary and inflationary expectations as rational consumer decisions on a micro level.

If you think cars will be cheaper if you wait to purchase (and so does everyone else), makers of cars will be forced to lower prices because consumers are not spending. If consumers see this lower price as a sign that prices will go even lower, the wait even longer. This deflationary spiral is what deepened and lengthened the Great Depression after and in the midst of the stock market crash, the banking panic, the protectionist trade contraction, the Hoover fiscal catastrophe (he cut spending and raised taxes), and the Federal Reserve that tightened monetary policy.

This deflationary spiral on a micro level is exacerbated by the employment picture and the spending contraction. As people see jobs losses, they begin to worry about their own job security. To mitigate job loss risk, they save rather than spend further deepening the car scenario above, and making further job losses even more likely.

The employment trajectory real complicates the problems we have. My hope was that a good fiscal stimulus (albeit too small) and credit markets brought back to life, could mitigate the downside risks to the economy, and give us life toward December. But now, the employment trajectory looks like a daunting hurdle. Via Brad Delong.