Recession as a self-fulfilling prophecy

Many of the fears that the American economy is headed into a recession are likely the cause of it making the recession a self-fulfilling prophecy.

Recession is defined as an extended period of time (generally 6 months) of negative growth, ie. a decrease in national GDP. There are many factors that go into calculating a nation’s GDP. The most important is consumer spending, which accounts for roughly two thirds of the total GDP (1). If consumer spending drops, then the GDP is likely to take a hit.

As a result, one must ask what it is that makes consumer spending drop. As it is, consumers are generally poorly informed. They do not always know exactly what is going on in the economy, but generally they follow general opinion including media reports and external influences such as friendly advice when they form their opinions as to whether or not we are going to face hard times economically.

If fears begin to circulate that the economy is headed for hard times, then consumers will begin to decrease their spending. As a result GDP will drop and the recession really begins to occur if it drops by a significant amount. Although actual output may not drop at all, if consumers are told that the economy is beginning to slow down, then they tighten their wallets and begin to slow their spending (2).

In essence, what has caused the recession is the fear that it would occur. If nobody mentioned that a recession was oncoming, then the consumers would not restrict their spending habits and the GDP would not drop. However, upon hearing that it’s the smart thing to save money, then consumers will stop spending and the economy will worsen as a result.

sources:
(1) http://www.reuters.com/

(2) http://www.marketwatch.com