Late last year I sat with members of my extended family and we talked about which banks might be safe havens for savings, and which might be about to collapse.
“Remember this conversation,” I instructed my young nephews. “The last time people talked like this was before your granddad was born.”
It made me think how the great crash of 1929, or the Great Depression, must have shaped the attitudes of those who lived through them. I used to think, in the arrogance of youth, that elderly people were just crazy if they stored their savings under the mattress because they didn’t trust the banks. Now I realise that painful memories, rather than senility, might explain the choice.
If experiences of major booms and busts shape the way we behave, it’s something that macroeconomists may need to take into account.
Consider two plausible theories of consumer behaviour, the “smoothie” and the “boomy”. The “boomy” theory is that when times are good, we get overconfident and spend freely, then retreat into a risk-averse shell when times get tough. The “smoothie” theory contends that people save for a rainy day in a boom and then draw down savings to maintain living standards during a recession. “Boomy” consumer behaviour makes recessions worse. The “smoothie” world is one where cool-headed and far-sighted consumers help smooth out booms and busts.
Keynes started with a boomy theory but abandoned it, believing it predicted implausibly wild swings in the economy. He switched to the smoothie theory instead in 1931. Here’s the intriguing thing: John Coates, the neuro-economist whose work on traders and testosterone I described two weeks ago, points out that the smoothie theory wasn’t borne out by US depression-era data at all. Americans became smoothie consumers only during and after the war. What happened? Perhaps consumers began smoothing only after being chastened by the memory of the roaring twenties and the subsequent hangover. And, says Coates, they began to return to unstable, boomy behaviour after 1981. Fifty years was long enough to forget.
A more formal analysis of these issues has been circulating since late 2006, well before the credit crunch, but has attracted new interest since. Ulrike Malmendier and Stefan Nagel, both California-based economists, have been investigating how economic experiences early in life seem to shape our later behaviour.
Using financial surveys that date back to 1964, they look at how returns on the S&P 500 over the course of an individual’s life to date shape his or her financial behaviour at the date in question. They control for age (perhaps 65-year-old retirees are always more cautious than 40-year-olds) and for the year (everyone investing in, say, 1988, faces a particular investing environment), but nevertheless find that an individual’s earlier experiences seem to shape his or her behaviour.
For example, young investors in the late 1990s were keen stock market investors, having experienced a lifetime of excellent returns; old investors were more cautious. Whereas in the early 1980s, it was the older investors who were more bullish: unlike young investors, they could remember the good times of the postwar boom.
If these results predict future risk attitudes, and if the credit crunch does prove to be the definitively unpleasant event that many economists fear, then a fascinating future lies ahead. Consumers will remember what it means to put money aside in the good times, while the stock market will be an old-timer’s game, tempting only for those greybeards who remember the long boom of the 1980s and 1990s. Those were the days.
Also posted at ft.com.