In this pandemic period, bad news about the economy abounds.
And while the extent of the economic repercussions from the coronavirus outbreak are still unclear, a new study that examined consumer spending behavior during the Great Recession can offer a cautionary insight: Be aware of the power of words.
That’s because when it comes to economic topics like unemployment rates, it’s not just necessarily the numbers — or the situation they represent — that deliver a blow to consumer spending, according to the study
by Stanford economist Hanno Lustig. It turns out words framing the figures pack a punch.
“We have evidence that the announcement of salient bad news — in and of itself — has a negative impact on how much consumers spend,” said Lustig, a senior fellow at the Stanford Institute for Economic Policy Research (SIEPR) and the Mizuho Financial Group Professor of Finance at the Stanford Graduate School of Business.
Consumer confidence levels are generally known to affect consumer spending, and this study sheds light on a piece of that puzzle, revealing a subtle but significant driver behind consumers tightening their wallets.
“Bad macroeconomic news typically goes together with an actual deterioration in the underlying economic fundamentals. But are people really responding to the fact that there's now a higher probability of them losing their job? Or is it also partly that they're just freaking out because there's bad news?” Lustig said.
“Our study shows that it's not just that they're updating their beliefs about the probability of losing their job at some point in the near future. But it's also that they're just responding directly to the salient announcement itself.”
The study, released in a working paper by the National Bureau of Economic Research, was co-authored by Lustig, Yaron Levi of the University of Southern California and Martin Garmaise of UCLA.
The analysis, the researchers say, is among the first to provide clear evidence of a sentimental effect on consumer spending — in this case, the reaction to the announcement of a 12-month unemployment peak.
When the researchers set out more than a year ago to examine the period of the Great Recession and its subsequent slow recovery, COVID-19 was nowhere in the news. They were not anticipating another recession, and certainly not expecting unemployment to hit levels not seen since the Great Depression.
“We had no inkling that this was going to suddenly become as relevant as it is now,” Lustig said. “That's obviously not something you hope for, but now that we're in this situation, we do hope that other economists will take us up on this challenge to try and learn more about how the salience of bad news is a big determent of spending. And maybe at some point, policymakers can try and take that into account.”
In their study, the researchers found that the mere news mention of a 12-month high in local unemployment rates — not the relative severity nor the actual rate itself — caused consumption for non-essential goods and services like restaurants, clothing or travel to fall by 2 percent within two weeks of the announcement.
And the negative effect on discretionary consumption persisted, too, lasting two to four months out, thus setting off adverse ripple effects that exacerbated economic conditions, the study found.
In contrast, consumer spending in other economically similar areas that faced the same unemployment rate and neared — but did not hit — a 12-month high, was not affected by the announcement.
Consumers reacted strongly even if the unemployment news turned out to be wrong. In areas where news incorrectly cited a 12-month high and was later revised, consumer spending also declined 2 percent.
Consumers in areas that repeatedly hit unemployment peaks for five consecutive months — which happened to nearly a third of the nation during the Great Recession — tightened their spending even more; the stream of bad news accounted for a nearly 5 percent drop in consumer spending.
“This is telling us something about how consumers are wired to respond to bad news. Consumers are responding purely to the fact that unemployment hits this 12-month peak. They're not responding to the unemployment rate itself,” Lustig said.
“So I think it’s incumbent upon policymakers and journalists to take into account how they communicate the bad news and to perhaps think of ways in which they could mitigate the impact of bad news.”
Bad unemployment news also leads consumers to assume the financing environment is facing challenges, pushing households more toward a precautionary savings mentality, the study found. Credit card repayments fell by 3.6 percent, and consumers also reduced their cash withdrawals.
People behave as if they are more financially constrained, even if perhaps they are technically not and haven’t lost their jobs.
In addition, households with lower income and lower education levels are particularly more sensitive to the bad news, reacting more strongly, the study found.
When the economic shocks subside and a recovery is underway, “our study suggests that things are not going to go to normal until you take care of the sentiment or the confidence level of the consumer,” Levi said.
“We are not saying that U.S. labor officials should delay the release of or massage the unemployment statistics,” Lustig said. “They should always announce the numbers when they become available, but I think they could try to provide context in the way they communicate it with the media to perhaps mitigate this effect.”
“You could make something seem more dramatic than it really is if you don't provide context to help households interpret the bad news,” he said. “So the gatekeepers can say, ‘Look, there was a bad number announced this morning, but here is the context: Let's take a look at recent history and guess what, we've been through this before, and we'll manage this time again.’”