Business Life: The psychology of a recession

30th June, 2010

First published in Business Life magazine, November 2009

The financial crisis has certainly taught me a few lessons. Sitting with my extended family one evening about a year ago, I advised them on which banks might or might not be about to collapse. It was the kind of conversation most of us thought had been consigned to the 1930s.
Our chat made me think about how the experiences of the great crash of 1929, or of the great depression, must have shaped the attitudes of those old enough to remember them. As a cocky youth I used to assume that the elderly stored cash under the mattress because they were too silly to understand how banks worked. Now I realise it may not have been senility – just the symptoms of a long memory.
Such issues are beginning to attract economic attention. 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 the 1960s, they look at how the stock-market returns each investor has witnessed tend to shape his or her behaviour. 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 experiences affect how they invest.
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. Yet in the early 1980s, it was the older investors who were more bullish: they could remember the good times of the post-war boom, and the young investors simply couldn’t.
Related work by Paola Giuliano of UCLA Anderson School of Management and Antonio Spilimbergo of the International Monetary Fund, looks not at investor behaviour but at political attitudes. Using a large annual social survey conducted in the US, the researchers ask how recession experiences shape those attitudes.
They discover that people who have been exposed to a sharp regional recession in their youth – between the ages of 18 and 25 – change their attitudes and carry those changed attitudes with them forever. They express a stronger preference for government redistribution, and they also tend to believe that success in life is more a matter of luck than hard work. They also tend to lose their confidence in government institutions.
As for the future, perhaps the stock market will become an old timer’s game, tempting only for those greybeards who remember the long boom of the 1980s and 1990s. That is, if the young revolutionaries born around 1990 don’t sweep the stock market itself away in a fit of revolutionary zeal.

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