Deconstructing consumer confidence

Posted: Wednesday, August 27, 2008

We have a market paradox on our hands. Consumer confidence is close to a 40-year low, suggesting that the economy is in worse shape now than in times that seemed far darker, such as the early 1980s, when inflation and unemployment both crept into double digits. Yet many of the current economic indicators, including inflation and unemployment, are rather positive - or at least not as negative as consumer sentiment implies.

So why are consumers, myself included, so gloomy?


The basic experiments on learned helplessness use two dogs, each in a separate room. In the control dog's room, after a bell rings the dog gets a mild electrical shock - just enough to annoy and surprise him. This dog has a switch to turn off the shocks and quickly learns to use it.

The second dog is yoked to the first but has no bell and no switch. Every time the control dog gets a shock, it, too, gets a shock until the control dog flips its switch. So, objectively, both dogs get the exact same treatment, but the yoked dog has no ability to predict or control the shocks.


And the second, yoked dog? You might expect it to be just as motivated to escape the shocks in the shuttlebox. But this is where the results get very interesting and somewhat depressing: The yoked dog just lies in the corner of its cage, whimpering.

The yoked dog learned in the experiment's first stage that shocks happen unpredictably and inescapably - and it carried that mind-set into the shuttlebox. This dog learned to be helpless in its general approach, exhibiting symptoms similar to suffering chronic clinical depression.


To give a personal example, about the time I got my first job, we were all told that technology stocks were the wave of the future and the best way to invest our money. When that bubble burst, we were told that housing was the best possible investment - but as my wife and I recently learned, this also was not the best advice.


One idea comes from psychologist James Pennebaker at the University of Texas at Austin. Pennebaker's research repeatedly has shown that the active process of trying to make sense out of traumatic events -- often done through writing -- can help individuals recover from them.


But we still need to think about how to prevent such economic shocks. In fact, in our current vulnerable state, I am worried that another immediate shock - most likely to occur in the health-care market - could be too much for us to bear.

I suspect that the only way to regain a sense of order, predictability and control is to have government take very clear and substantial steps to regulate the markets - steps far beyond the patch-up jobs the Federal Reserve Bank is doing now.


We need forward-looking policies that stave off potential problems in markets that have not (yet) failed. Or at least policies that sort out in advance how we will deal with crises as they emerge. Under what circumstances the Fed bails out banks, for instance, and what would be the consequences for the shareholders, the bank and the bankers. I suspect that only such large-scale and forward-looking policies will allow us to regain our general sense of order, predictability, control and trust - and help us stop feeling like the yoked dog.

• Dan Ariely is a professor of behavioral economics at Duke University and the author of "Predictably Irrational: The Hidden Forces That Shape Our Decisions." This column was written for the Los Angeles Times.

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