The Untold Story of the Recession: The Psychological Cost

The psychological cost of a few years of recession can wipe out the benefits of many years of growth. Jan-Emmanuel De Neve of the Centre for Economic Performance explains his latest research on the effect of the recent recession on people's wellbeing.

How do macroeconomic changes affect people’s wellbeing? The psychological impact of economic expansion and recession is particularly salient given the massive swings of recent decades – see-sawing from boom to bust and back again. The new CEP study reveals an important asymmetry in the way that individuals experience positive and negative fluctuations of the business cycle.

To explore how individuals react to positive and negative growth, the researchers analyse wellbeing measures from three large datasets: the Gallup World Poll of 151 countries; a representative sample of 2.5 million Americans; and Eurobarometer, a twice-yearly opinion survey conducted by the European Commission.

In general, they find that growth is significantly associated with wellbeing. But when split across positive and negative growth, this result is mostly driven by the negative growth years. Recession years are significantly associated with losses in wellbeing, but there is not an immediate relationship between positive growth years and wellbeing.

Greece’s experience is illustrative. The country’s real GDP grew by more than 50% between 1981 and 2008, while life satisfaction edged up by 5-10% overall (with most of the gains made over the decade of stable growth to 2008). But the recession that began that year led to a decrease in average wellbeing that erased all prior gains. Average wellbeing in Greece now stands at a level below historical records, despite real GDP remaining at a level well above historical figures. The psychological costs of the recession cut even deeper than the negative growth numbers would indicate.

So why do people experience macroeconomic losses more negatively than they experience equivalent gains positively? A deep-rooted mechanism could be that individuals simply react more strongly to negative developments. People’s disproportionate sensitivity to negative stimuli may have an explanation rooted in evolutionary biology, since in terms of survival the avoidance of threats is more important than a missed opportunity.

Periods of economic contraction not only involve a loss of national income but also an increase in uncertainty, which is arguably intensified by the disproportionate coverage of negative news about macroeconomic trends compared with positive trends. Volatile business cycles and the resulting uncertainty are also attention-seeking stimuli.

Jan-Emmanuel De Neve comments:

'Our findings suggest that policy that is designed to engineer booms but which risks even relatively short busts is unlikely to improve wellbeing in the long run.

‘Growth policy can not solely be evaluated on the basis of how much the economy has grown but needs to also be understood in terms of how the economy has grown. The psychological impact of the growth trajectory—whether volatile or smooth—is understudied even though it is felt strongly by ordinary citizens and results in markedly different reports of life satisfaction.’

‘Steady positive growth that minimises the risk of contraction seems the most likely route to improving general wellbeing.’