If a prediction of a recession causes the market to crash, can it be said that the prediction itself is part of the cause of the recession? Like a self-fulfilling prophecy?
In: Economics
Recession expectations can be self-fulfilling via the [paradox of thrift](https://en.wikipedia.org/wiki/Paradox_of_thrift), but not in the way you have worded it. First, we need to define the basic concepts you mentioned:
A **recession** is when total national income, measured by GDP, along with other measures such as employment and retail sales, falls for several months across the country. Think of this as a real, sustained reduction in economic activity.
A **market crash** is a severe drop in the value of stocks and other financial assets. It can be driven by some short-term shock, including psychological factors, or it can be driven by new information and expectations about what’s going to happen to corporate profits–including due to falling expectations for economic growth.
**Predictions**–generally referred to as “expectations” by economists–might be those of 1) stock market traders and financial institutions, 2) the Federal Reserve (the central bank of the US), or 3) the average consumer.
How do these things fit together?
1. If these traders and financial institutions freak out and the market crashes, it is unlikely to cause a recession. Some of the worst recessions in the past have been caused by financial crises, but most financial crises do not cause recessions. The stock market crash at the end of the 90’s internet bubble is a very good example of this. Investors realized they’d overvalued a bunch of tech stocks, causing a massive sell-off. But most economic activity went along the way it was, since it didn’t directly affect them.
2. If the Federal Reserve thinks a recession is coming, they will cut interest rates further to prevent it. So Fed expectations of a recession are more likely to *stop* a recession than cause it.
3. If the average consumer anticipates a recession, *this is where things get dangerous.* When consumers expect hard times ahead, they cut back on spending and start saving for a rainy day. But, by doing that, they cause a reduction in overall spending (aggregate demand) and thus cause businesses to cut back on investment and employment, leading to a recession. This is the classic “paradox of thrift” scenario.
TLDR; Predictions of a recession might cause a recession, but not because of the market crash. The predictions might cause a recession by freaking the average person out and causing them to cut back on spending.
Latest Answers