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ECONOMY: The Confidence Conundrum

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By Peter G. Hall, Vice-President and Chief Economist EDC *

Losses were legendary across a number of indicators in the immediate aftermath of the 2008-09 recession. Some have staged a remarkable comeback, while others remain in the red. Confidence is among the laggards, especially in the richest economies, stoking the debate on its overall importance and its role in the elusive economic recovery. Is it the fixer, or is it waiting for something to fix it?

Recent confidence data are hardly inspiring. Following an impressive post-recession surge, the Euro-area Economic Sentiment Indicator has been in freefall since early 2011, and is now well below average. America’s story is quite different. Confidence plunged to depression-like levels in 2009, and recovered – to recessionary levels, where it has remained submerged ever since. It is highly unusual to see such persistent pessimism in the U.S. Two recent attempts to resurface fizzled out.

Confidence is an essential element of an economic system. Consider our fractional banking system. By definition, there is not enough money on hand to honour all deposits – but confidence that banks can honour individual claims to deposits keeps the system going. Violate that trust, and mayhem breaks out – a panicked rush of withdrawals can ruin even a solid financial institution. Food supplies work the same way. Rumours of shortages can actually create shortages, as retailing cannot deal with sudden stockpiling. Confidence in the distribution system is essential to its proper functioning.

Currencies also depend on confidence. Runaway inflation, capital flight and compromised security are quick examples of events that can quickly undermine any currency’s role as a dependable medium of exchange. Small wonder that one of the key functions of any central bank is to preserve the value and sustain common trust in its national or regional currency.

Global economic confidence was sorely tested during the Great Depression. In the early 1930’s, activity levels remained extraordinarily low, even after the excesses of the roaring ‘20s were soaked up. The shock of lower activity and extremely tight liquidity seized up commercial flows, and conditioned businesses and consumers to operate at levels well below normal – if you like, ‘new normal’ thinking. What the economy seemed to need was a reset to jolt it back to normalcy.

Back then, public stimulus was the answer, and deficit financing was born. This time, we resorted to that right away. History will likely conclude that we jumped the gun, exhausting our best fiscal ammunition well before the economy had a chance to run down the global economy’s substantial pre-recession excesses. The economy still awaits a restart, but there are fewer policy options at hand.

It seems to fall more to the economy’s natural dynamics to lift growth and restore confidence. Sadly, pessimism’s persistence has us spooked: when the latest data are weak, it seems to confirm the gloom, and positive data are met with scepticism. This has us locked in a sort of ‘trust-trap’ that is proving hard to get out of.

The bottom line?

Confidence is one of those economic elements that, like other things in life, you don’t know what you’ve got ’til it’s gone. Until you get it, it’s like a paradise lost. But when you do get it, you forget it – it hums along nicely in the background. Let’s hope it’s not gone for too much longer.

The views expressed here are those of the author, and not necessarily of Export Development Canada.


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