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My Two Cents

Adjusting expectations

Chris Farrell Jan 28, 2009

One way of looking at what is happening to the eocnomy is that people are adjusting their expectations, and that takes time.

Over time people develop rules of thumb. They’re based on experience and conversation. So, it used to be a reasonable expectationn that if someone lost their job they would get another one within 3 to 6 months (at the outside). That was the foundation of the common personal finance advice that you should set aside 3 to 6 months of savings. Fact is, that’s hard to do. The reality is that when someone lost their job they would cut back on spending, tap into savings and borrow on their credit card. It’s a good approach for 3 to 4 months of looking. And the rule of thumb is that you’d get something comparable, maybe not quite as much pay or as generous benefits, but within striking range of your rpevious job.

But then the world changed, and it took time for us to adjust. What if instead of 3 to 6 months it took 6 month to a year to find a job. And what if it turns out that the risk of taking a 50% paycut in your new job go up dramatically. All of a sudden the use of a credit card becomes onerous. Instead of tapping into it for 3 months, you end up using it over a year. And then, not only is your debt burden bigger, but your earning less in your new job and it takes longer to pay it off.

People weren’t stupid. People weren’t lazy. The world has changed, and we’re adjusting our expectations.

Now, expand this to the economy. In the 1990s, students and their parents complained about the high and rising cost of a college education. But we paid it. The reason is that the earnings of a college graduate more than paid for the big debt burden. But while the real student loan debt burden has gone up by 50% in the 2000s, the real wages of college graduates has declined since 2002. The risk of taking on all that debt has gone up.

Similarly, the real estate bubble. There is a loot of blame to go around and I’m not minimizing all the greed and craziness. Still, Mike Mandel, the chief economist at Business Week, and I were discussing the other day an aspect of the boom and bust that isn’t emphasized enough. People expected the economy to keep on growing and wages to catch up with productivity improvements. It wasn’t a foolish expectation. It wasn’t a mass mania. It was a reasonable expectation.

But economic growth was weak. Wages did not catch up with productivity in the 2000s. The optimistic bet that paying up for a house and other borrowings would end up okay–which was the experience from the 1950s through 1995 or so–turned out to be very very wrong. Yes, a bad bet, but not stupid.

What’s happening right now, with all the emphasis on paying down debt, is that people are assuming growth and wages aren’t going to be good for years to come. We’re devising rules of thumb that are far more cautious–and that’s the right thing to do.

But it’s truly worrisome. It’s easy to make fun of optimism. The bubble-moralizers are having a field day. But its the belief that tomorrow will be better than today is the entrepreneurs credo. It’s what every middle class family wants for their children. It’s the engine of economic growth. The spread of pessimistic rules of thumb isn’t a good sign..

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