Fear of double dip recession can cause one

But as the economist John Maynard Keynes cautioned long ago, such market reactions are basically a “beauty contest” — with investors trying to predict the short-term reaction that other investors think still other investors will have.

In fact, there is still a real risk of a double-dip recession, though it can’t be quantified by the statistical models that economists use for forecasts. Instead, the danger stems from the weakness and vulnerability of confidence — whose decline could bring markets down, further stress balance sheets and cause cuts in consumption, investment and local government expenditures.

It is the fear of fear itself, of which Franklin D Roosevelt famously spoke.

Abating scare
From 2007 to 2009, there was widespread concern about the risk of an economic depression, but that scare has been abating. Since mid-2009, it has been replaced by the milder worry of a double-dip recession. And with that depression scare still fresh in our minds, sensitivity to the possibility of another downturn remains high. To be sure, many economists doubt that a double-dip recession is in store.  However, I use a definition of a double-dip recession that doesn’t emphasise the short term. Instead, I see it as beginning with a recession in which unemployment rises to a high level and then falls at a disappointingly slow rate.  Before employment returns to normal, there is a second recession. As long as economic recovery isn’t complete, that’s a double-dip recession, even if there are years between the declines. Under that definition, there has been only one serious double-dip recession in the last century — it started with the 1929-33 recession, which was followed by a recession in 1937-38.

The Great Depression
Between those declines, the unemployment rate never moved below 12.2 percent. Those two recessions, four years apart, are now typically lumped together as one event, the Great Depression.

We have to deal with a similar — though less extreme — problem today. Many of us are unsettled by images that are preventing a return to normal confidence — images of rioting in Athens, or of baffled American traders during the nearly 10 per cent drop in the stock market on May 6.  And if the BP oil spill is not soon contained, and eventually wreaks havoc on the gulf economy, we may need to add it to the list, too. Consider the May 6 stock market plunge. Though it reversed quickly, it awakened fears of instability, which can change the atmosphere and delay recovery from a recession, possibly even until the next one comes around.

Confidence indexes and other measures of public thinking show gradual trends, often over years, that don’t match up precisely with economic events, which are often sudden. We need to look at short-run events, like the market reaction to the Greek bailout, as no more than side effects. Slowly moving changes in our animal spirits represent the real risk of a double-dip recession.
The New York Times