Can gloomy talk doom the economy? In the past, economists dismissed the notion. The theory went that no matter how many downbeat headlines people read, the theory went, the outlook always comes down to basics such as jobs, incomes, and profits.
But in today's economy things are so much more complicated and confusing for the populous. In these times psychology does indeed have a huge impact on the stock market, and never before has the market played such a big role in real economic activity. It was the market's psychology more than fundamentals that drove financial share prices up so rapidly in early 2000s. The resulting surge in wealth was the jet fuel to the financial crisis. Then the chairman of the Federal Reserve, Ben Bernanke starts to bailout financial giants.
Now, psychology has turned sharply. In addition to market worries and a negative spin by the press on almost every new piece of data, the chairman of the Federal Reserve, Ben Bernanke warns of a possible "protracted slowdown.” Such talk is meant to promote the idea of a new U.S. stimulus plan, but downbeat sound bites continue to hit home. No wonder households are becoming more pessimistic.
Sentiment, especially on Wall Street, is so negative right now that the surprisingly big shift in the Federal Reserve's thinking about the possible need for lower interest rates failed to lift spirits. In fact, the stock market went south in a hurry after the Fed's decision to start bailouts, even though the central bank shifted its major concern for the future away from inflation and toward economic weakness.