Wednesday, April 08, 2009

Feeling the recession & the wind chill factor

As anyone who has gone for a bracing walk in the Wicklow Mountains knows, when there is a stiff breeze, it feels colder than it actually is. The wind chill factor is well documented and obeys a simple non-linear equation see below.
Something similar seems to be happening vis-a-vis the recession. Lets say living standards (i.e. GNP per capita) have fallen 5% in the last 6 months. Maybe they will fall 10% in the next year. That only gets us back to where we were in say, 2007, when the mood was pretty good. Most people would cheerfully swap our present situation to be back in 2007. So why does it feel worse? The obvious answer would seem to be loss aversion: we feel losses more than gains at the margin, about twice as much on average.
But this would only get us back to 2004/05 when again the mood was pretty good. So I think something else is going on; perhaps its the anticipation of further losses or maybe people care not just about levels but about slopes i.e. the time derivatives so that it is painful when things are getting worse (as distinct from being worse).


sam said...

great article.

See this piece of information also:

Tips to be recession proof this year

Liam Delaney said...

a few things that are going on that should be factored in:

asset price depreciations: I am trying to factor this is into some of our survey work. for example, it might be legitimate to feel bad if you purchased a house on a 100 per cent mortgage that is now worth less than what you bought it for. Depending on the expectations that you had formed, this amplifies the reduction in living standards.

Related to this is the issue you mentioned of reference effects. This recession is certainly not whacking everyone equally. If your job is steady and you bought before 2004, then the tax levy is the thing that is really hitting you. But compared to someone who bought in 2007 and now is facing a ropy job prospect, this is a good position. The latter guys must be looking to the former and feeling a pang of negative reference effects. The Taoiseach used the phrase "staying in the game" to refer to the position of people struggling along. This is a good analogy. There is a non-trivial cohort now who have to expend a lot more effort just to keep up. Its not impossible that a group of these may consider just throwing in the towel and filing for bankruptcy.

Also, about 350000 people are unemployed and this is very likely to hit at least 400000. While mean living standards may only fall by 10 per cent or so, in some sense the mean is less interesting when you are looking at well-being than whats going on in the left-tail. I wont go again through all the evidence but it is really substantial that involuntary unemployment both exists and is a substantial source of pain.

Other factors that might be causing genuine distress as opposed to just dips in income include:

- identity costs from not attaining goals.

- stripping down of front-line services, particularly from people who may be isolated.

- identity costs from not meeting commitments. I have spoken to quite a few people who express huge degrees of stress about not being able to meet commitments, whether to employees, suppliers or whatever. This stress may be far more than the effect of, lets say, dropping an equivalent amount of income in a general sense.

Kevin Denny said...

Good points...except isn't it 350,00 on the Live Register, these aren't all unemployed?
Obviously there is huge heterogeneity in how people are being affected.I don't know if the data will allow one to say what happens to inequality.This must be tricky with big asset price effects.

Liam Delaney said...

yes, you are right - not all the live register people are fully unemployed. there is also a debate about the extent to which some people claiming disability or otherwise out of the labour market are in some sense unemployed. I have certainly met people who are in their early sixties and are on disability payments who would prefer to work and look, to me, to be in a classic structural unemployment position dressed up as disability. These guys are likely to feel this as much as someone technically unemployed.

Another issue that will become tricky in the next few years when thinking about inequality will be looking at the real value of debt. People who racked up thirty or forty thousand in non-mortgage related debt when inflation was 6 per cent will be hit relatively hard if deflation keeps going like this. Of course, they will have lower prices to console them but still will be hit worse than people without this type of debt. I do not know the extent to which different types of loans taken out between, say, 2000 and 2005 adjust to the new lower interest rates. Many of them, I suppose, will just continued to be paid at the interest rate agreed. A programme where people were pushed into taking independent financial advice about how to restructure their finance would be an interesting thing to think about.

Mark McG said...
This comment has been removed by the author.
Mark McG said...

According to Brad DeLong, of the $20 trillion decline in global financial asset value, only a very small portion can be attributed to losses on mortgage backed securities etc.

He argues that over 90% of the decline (so $18+ trillion) is due to changes in preferences for risk and information.