We expect our political leaders to manage the level of economic activity by employing fiscal and monetary tools such as interest rates, tax incentives and stimulus packages to avoid recessions. However, in the aftermath of the bursting of the largest bubble in history, in the property market as well as other markets, we see that a social-psychological phenomenon, over-confidence, was not managed by leaders, and its subsequent collapse represents the deepest cause of the financial crisis.
We can imagine that words of warning might have been effective in stopping the bubble before it got so big. Alan Greenspan’s “irrational exuberance” speech in 1996 had a briefly chilling impact on stock markets around the world. However, in the years just before the crisis, leaders failed either to issue firm notes of caution or to restrain over-enthusiastic investment by changing economic incentives.
Now the danger is that we will languish in a period of under-confidence. The over-confidence of a few years past, which encouraged many people to leverage themselves in questionable investments in property, has now left us with a legacy of damaged portfolios. In this uncertain economic climate, businesses are hesitant to invest and consumers reluctant to spend. For a particular business or family, such hesitation may seem wise. However, the cumulative impact of individual decisions based on low confidence is an economy that stalls, either failing to recover or slipping once again into a recession.
To what extent can leaders influence economic confidence? Successes in managing economic confidence are legendary, but rare. The most famous example is that of Franklin Delano Roosevelt in managing the banking crisis during the Great Depression.
Just consider what happened then. In the winter of 1932-33 bank runs in the US occurred in state after state. By the time Roosevelt took office on March 4 1933 the economy was at a standstill, with a quarter of the workforce unemployed. More than half the states had declared a temporary bank shut-down and there were severe restrictions on bank withdrawals in most of the rest.
In his March 4 inaugural address he took an already well-known phrase, “The only thing to fear is fear itself” (popularised a couple of years earlier by Thomas Mullen, publicity director for Mayor James Curley of Boston), and made suppression of fear and willingness to support the economy a moral obligation, for everyone.
Roosevelt’s first action as president, slightly after midnight of his first full day in office, was to make the bank shut-down national. He closed all US banks on March 5. But he also made an effective plea. He started the tradition of connecting with his people with personal radio messages. They became called “fireside chats”, because they seemed like cordial one-on-one conversations.
These were enormously successful, attracting wide audiences. In his first on Sunday March 12, when he announced the reopening of banks the next day, he asked people not to rush to take their money out: “The success of our whole great national programme depends, of course, upon the co-operation of the public – on its intelligent support and use of a reliable system.” The fireside chat was a scenario designed to ask for moral commitment and confidence in each other.
When the banks reopened the next day, the nation held its breath. Would the bank runs continue? Or would people reach for their savings under their mattresses and redeposit them, letting the recovery begin? Luckily they redeposited and capitalism survived.
There is evidence that the public spirit that Roosevelt cultivated was central to the initial success of his plans for economic revival. A March 13 report in The New York Times asserted that, even though people could not access their bank accounts, there was a marked increase in cash church offerings on the two Sundays of the bank shut-down, so strong that it led one usher to think that “some kind of currency inflation had gotten completely out of control”. It seems that Roosevelt’s plea for citizens to think of the common good had translated into an impulse to help others.
In addition to working to elevate the public mood, Roosevelt introduced many economic innovations. As part of the New Deal, Roosevelt started Federal Deposit Insurance, the Securities and Exchange Commission, and Social Security, to name a few. Undoubtedly, the concrete steps he took to provide economic safeguards worked in tandem with his inspirational messages. Indeed, there was steady improvement in the economy during the years 1933-37.
The public support for Roosevelt lasted for a remarkably long time given that the US remained in a depression. He was re-elected in a landslide victory over Alf Landon in 1936, even though the unemployment rate remained shockingly high (at 14 per cent). Part of Roosevelt’s support may have resulted from the moral connection he made with the people, reinforced by his concrete actions.
But such successes of national leaders in boosting economic confidence are rare. Roosevelt’s fireside chats started a tradition that has been followed by every US president since, but none has had as much success in influencing public opinion. Fireside chat pleas from leaders have mainly been effective during national emergencies. Winston Churchill, the former British prime minister, perfected the form, but only during the awful days of the second world war. President John F.Kennedy waited six months until the opportunity provided by the 1961 Berlin crisis (and a sudden public fear of nuclear war) for his first fireside chat. It is easy to see why it is hard for leaders to use such a medium to restrain the over-exuberant animal spirits that lead eventually to an economic crisis.
Both Barack Obama and Gordon Brown, the British prime minister, have been attempting the same moral rhetoric as Roosevelt used, though without as much impact. Mr Obama repeats the “fear is fear itself” line, and in one of his weekly addresses last year said: “Americans didn’t build this great country by fearing the future and shrinking our dreams.” Mr Brown appears on Number 10 television sitting beside his Downing Street fireplace, talking about public responsibility and integrity. But, if YouTube counts are any guide, only very few are watching these chats.
The 1933 Roosevelt example shows that such efforts can help. Leadership matters. But it can be effective only sometimes. And leadership in a crisis cannot undo all the damage of lack of leadership in the past.
The writer is the Arthur M. Okun professor of economics at Yale University and co-founder and chief economist of MacroMarkets
Get alerts on European banks when a new story is published