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The Journal of Socio-Economics 40 (2011) 652– 659
Contents lists available at ScienceDirect
The Journal of Socio-Economics
jou rn al h om epa g e: www.elsev ier .com/ locate /soceco
psychosocial explanation of economic cycles�
iguel Pereira Lopes ∗
ocial and Political Sciences Institute, Technical University of Lisbon, Rua Almerindo Lessa, 1300-663 Lisboa, Portugal
r t i c l e i n f o
rticle history:eceived 13 July 2010eceived in revised form 11 May 2011ccepted 30 May 2011
EL classification:125011500110
a b s t r a c t
How human expectations and behaviors impact the economy has been of interest to economists sinceat least Adam Smith. However, recent advances in psychological and social psychological research haveled to an improved level of knowledge about human adaptation processes, as well as about optimisticand pessimistic expectations and their consequences on human behavior. These developments allowus to understand these adaptive expectations and behaviors in a more integrated fashion. Based onthese improvements, I develop a model of human adaptation under different external circumstancesand apply it to explain the ups and downs of economic cycles. A central conclusion from the modelis that optimistic expectations of economic agents might not always have a positive impact over theeconomy. I conclude by drawing theoretical implications, as well as potential consequences for financialand economic policy-making.
© 2011 Elsevier Inc. All rights reserved.
eywords:conomic cyclesuman adaptationptimismessimism
erceived control. Introduction
In a recent address on the topic of “the economics of happiness”,he chairman of the US Federal Reserve,1 Ben Bernanke, cited Adammith’s (1759, p. 119) observation that “[T]he mind of every man,n a longer or shorter time, returns to its natural and usual state ofranquility. In prosperity, after a certain time, it falls back to thattate; in adversity, after a certain time, it rises up to it”. Bernankeas citing Smith to stress the importance of understanding thesychosocial processes of human adaptation to different social andconomic environments, particularly those in which the material
conomy does not seem to perform so well.Transmitted from Smith, right down to our days, this messages still to be assimilated by economics in order to better under-
� This research was supported by a post-doctoral fellowship (SFRH/BPD/6127/2009) awarded to the author by the Portuguese Governmental National Sci-nce Agency Fundac ão para a Ciência e a Tecnologia, Ministério da Ciência e do Ensinouperior. The author thanks to two anonymous reviewers their insightful com-ents and suggestions. The author also acknowledges the support from Centro dedministrac ão e Políticas Públicas (CAPP) at the Technical University of Lisbon.∗ Tel.: +351 21 361 94 30; fax: +351 21 361 94 42.
E-mail address: [email protected] Commencement Address entitled “The Economics of Happiness”, University of
outh Carolina, Columbia, South Carolina, May 8, 2010.
053-5357/$ – see front matter © 2011 Elsevier Inc. All rights reserved.oi:10.1016/j.socec.2011.05.004
stand how humans handle the challenges and threats they find intheir context. It is true that eminent economists, such as Schum-peter and his socio-economic perspective, have enlarged the lens ofanalysis of economic behavior (Swedberg, 1995). However, giventhe advances in psychological research that have occurred overthe last decades, new and more comprehensive models need tobe developed.
Some economic approaches have highlighted striking similar-ities between biological and technological/cultural evolutionaryfeatures, claiming that social systems consist of collective humanbehavior with origins in the human biological system (Devezas andCorredine, 2001). These authors stress that regularities in humanbehavior manifest themselves as socioeconomic rhythms and thatthe cyclical nature of social phenomena is ingrained in the humanbiological structure. In the same line, we must acknowledge thatleading authors in the field of economic psychology, notably Katona(1968), long ago launched the seeds of an adaptive theory of con-sumer behavior.
These pioneering works were followed by a surge in psycho-logical research and understanding of core explanatory concepts,such as expectations, optimism, pessimism, and perceived control
over events. I believe the time has come to put all this new knowl-edge into an informative model of how people adapt to changingeconomic conditions and how their consequent behavior, in turn,influences the development of the economy.
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As such, the goal of this paper is to present an integrated andp-to-date model of human adaptation to an economic changingnvironment. To achieve this goal, I first discuss the major incre-ents in psychological knowledge on key constructs to understand
uman adaptation, such as appraisal and coping (Lazarus, 1991).n addition, I also aim to outline implications for economic the-ry regarding how and why people react to different economiconditions, particularly across different economic and businessycles.
I foresee at least two advantages to be gained from a betternderstanding of the psychosocial processes that underlie humandaptation and behavior in response to different economic con-exts. First, traditional economic theories about economic cyclesan be enriched with a behavioral perspective of why and how peo-le engage in overoptimistic or pessimistic expectations and whyhey change their behavior accordingly. This, of course, follows theesurging importance of a behavioral economic perspective thate have seen over the last decades (Akerlof and Shiller, 2009;ahneman and Tversky, 1979; Thaler, 1980). Second, by under-tanding the human adaptive psychosocial processes underlyinghese expectations, economists can best inform policy-makers inerms of their own goals. For instance, policy-makers usually rely onhe assumption that to beget more active consumers (i.e., stimulat-ng consumption) authorities should implement policies to nurtureositive optimistic expectations, such as lowering a central bank’s
nterest rate (De Grauwe, 2008). But as I shall demonstrate, in someircumstances optimistic expectations might, in fact, lead to lessroblem-solving behavior and to higher passivity on the part ofonsumers (Aspinwall et al., 2005).
Understanding the mechanisms that regulate these adaptiveehaviors under different circumstances (e.g., upswing or down-wing) can thus help us to better intervene in the economy at
macroeconomic level. Psychologically informed explanations ofconomic cycles and financial crisis have already been advancedn the literature (e.g., Schwartz, 2010), including topics suchs mental biases, envy, and illusions. In this case, however, Iase my research on the specific literature of human adapta-ion processes and I hope to contribute toward enlarging ournowledge of how psycho-socio-economic mechanisms can informs about these phenomena and how we can influence themccordingly.
In the remainder of this paper, I review the major tradi-ional explanations for economic cycles that have been proposednd then discuss the state-of-the-art on human adaptation the-ries in psychological and psychosocial research, ending thatection by presenting an integrated model of human adapta-ion. I then discuss a psychosocial explanation of economic cyclesn the light of the proposed model and finish the paper byrawing conclusions and implications for economic theory andolicy-making.
. Current explanations for economic cycles
The existence of recurring patterns of economic activity hasong intrigued economic scholars (Kleinknecht, 1986; Kondratiev,935).2 Schumpeter (1939) was perhaps the most notable of the
rst economists fascinated in teasing out the causes of these pat-erns and he showed particular interest in integrating differentong-tale types of waves, namely Kondratievs (structural eco-2 “Economic Cycle” and “Business Cycle” are disputed empirical phenomena.owever, given the core of this theoretical paper, we will assume their factual exis-
ence and will not make that discussion here. For further knowledge about this topic,eaders are referred to e.g., Hartley et al. (1998) and Grandmont (1985). I thank annonymous reviewer for noticing the need to make this explicit.
onomics 40 (2011) 652– 659 653
nomic development changes occurring in a range of about 48–60years), Kuznets (based on migration and investment in construc-tion occurring in cycles of about 15–25 years), Juglars (investmentin machines occurring in cycles of about 7–11 years), and Kitchins(inventory investment cycles occurring in turns of about 3–5 years)(De Groot and Franses, 2008).
The cyclical behavior of economic variables such as GDP growth,employment, or interest rates is such that it resembles the fea-tures of a fractal with the different types of cycles nested withineach other. As some have noted, the relationships between thesecycles is so tight that one can even establish the direct functionsof 1 Kondratiev-type of wave happening for each 3 Kuznets, eachKuznets happening for each 2 Juglars, and each Juglar happening foreach 2 Kitchins (or 1 Konratiev = 3 Kuznets = 6 Juglars = 12 Kitchins)(Van Duijn, 1983).
In the same vein, Schumpeter also viewed business cycles aspulsations of the rate of economic evolution (Kuznets, 1940). Hismost salient explanation for the different pulsation rates of theeconomy was the innovation process (Rosenberg and Frischtak,1983; Swedberg, 1995; Schumpeter, 1939), which according tohim, helped to explain the long cycles through the understandingof how innovation brings both cyclical instability and economicgrowth.
The core explanation of Schumpeter for the existence of eco-nomic ups and downs lies in the discontinuity of the distribution ofentrepreneurial ability. As Kuznets (1940, p. 259) asserted, “Thisability to dare, to initiate, to overcome obstacles to innovationsis, like many other abilities, distributed along a curve which sug-gests that there are few individuals endowed with such ability toany great degree”, and it is the activity of these entrepreneurs thatdestabilizes and promotes instability in the economic system.
Considering that the innovation process and the entrepreneur’saction is behind the occurrence of economic and business cyclesmeans that human behavior is at the roots of economic behavior. AsKuznets (1940, p. 266) puts it, “for whatever quantities reflect cycli-cal changes, these changes result from discrete acts by individuals(. . .) in the social system”. If true, understanding the psychologicalmechanisms behind the different behaviors that humans actuallyshow while they try to adapt to different economic stages is acrucial element of the explanation for economic upswings anddownswings. However, despite the importance to better under-stand these human adaptation processes to an economic changingenvironment, there is scant literature on this topic.
A close research area to which one can refer are the pioneer-ing studies of Katona (1968), which launched the basis of a lineof research evidencing the influence of the “consumer sentiment”on consumer expenditure and buying patterns. Katona’s propos-als and assumptions are considered the first main explicit adaptivetheory of consumer behavior using socio-psychological principles.Although he did not directly address the issue of economic cycles,these were always related to his work because, as he asserted, themajor psychological variables used in his research, such as expec-tations and attitudes, “are believed to be related to fluctuations inthe business cycle” (Katona, 1957, p. 120).
In any case, Katona (1968) foresaw the critical variables thatseem to be necessary in explaining economic variation derivedfrom consumer behavior. First, he stressed that human responsesare a function both of changes in the environment and the person(R = f[E,P]), which led him to acknowledge that motives, attitudes,and expectations are intervening variables that mediate betweenstimuli and responses, and are acquired through past experience.Second, he verified that human wants are not static and that opti-
mistic/pessimistic expectations play a critical role in explainingconsumer behavior.He specifically found that expenditures and consumption arenot a mere function of the ability to buy (i.e., income) but also of the
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illingness to buy (i.e., the consumer sentiment) and that expectedncome trends have a greater effect on buying plans than pastrends, particularly concerning discretionary expenditures such asars, housing, leisure-time, and so on (Katona, 1971). Using an indexf consumer sentiment (i.e., consumer optimistic outlook regard-ng future income), Katona (1974, 1979) found that when a wavef pessimistic expectation and feeling arose and attitudes deterio-ated, consumer discretionary spending decreased and a recessioneveloped 6–9 months later.
Although not specifically developed to understand economicycles, Katona’s work is of extreme help to that important task.ut one must acknowledge that Katona’s work has itself multi-le facets and raises ambiguous conclusions. For instance, whilee clearly distinguishes between optimism and confidence on thene hand, and pessimism and uncertainty on the other (Katona,979), he also considers that it is not how optimistic or pessimisticne feels that matters, but mostly the “change in attitude” onexperiences (Katona, 1971, p. 125). In other writings, he also clar-fies how he believes uncertainty and lack of confidence arise. Hisxplanation is that people as a whole start to view their futures uncertain “when a substantial proportion and a similar propor-ion is pessimistic” (Katona, 1979). This, of course, is very differentrom considering pessimism and uncertainty as always relatedKatona, 1979). Still in another passage, Katona (1979, p. 122)sserts that “growing optimism dispels uncertainty (say, in 1965)ut also that growing pessimism dispels uncertainty (say, in 1974)”.s explained below, these are not simple nuances without impor-
ance. On the contrary, as I will explain, clarifying these distinctionsf when optimistic or pessimistic beliefs become productive is athe heart of an accurate theory of human adaptation to economichanges.
For all this, I turn now to discussing the roots of an integrativeuman adaptation based on the most recent findings of social psy-hological research. Later I discuss how this psychosocial model ofuman adaptation can help us to draw an adequate and comple-entary explanation of economic cycles.
. Psychosocial approaches to human adaptation
Although the interest in understanding how people react to theirnvironment and the perceived threats and opportunities thereinan be traced back to at least the principal philosophers of ancientreece, the topic of human adaptation has gained an increased
mportance in social psychological literature in the second half ofhe last century (Scherer, 1999).
This does not mean that social psychologists were the only onesoncerned with human adaptation issues. It is certain that scholarsrom other sciences have long focused on the problems associatedith human adaptation processes, such as Sigmund Freud in theeld of psychoanalysis (Freud, 1937) or Erik Erikson in the area of
dentity development through the human life cycle (Erikson, 1974).owever, social psychologists have long based their approaches onxperimental and clearly scientific-based methods, thus bringing aeliable and significant set of validated concepts and theories thatave attracted the interest of many researchers and boosted theumber of investigations on the topic of adaptation.
One of the most acknowledged psychosocial perspectives onuman adaptation is that of appraisal and coping theories (e.g.,azarus, 1994, 1991, 1966). Scholars investigating these issues haveuilt on the emergent concepts of appraisal and coping to develop aniversal theory of human adaptation. These works have appeared
n top journals in psychology (Folkman and Lazarus, 1985, 1988;
azarus and Smith, 1988), and have inspired much of the recentork on the issue of human adaptation. For this reason, I base muchf the conceptual analysis that follows on the core concepts of thistream of research.
onomics 40 (2011) 652– 659
3.1. Current state of human adaptation theories
As briefly introduced above, current psychosocial theories ofhuman adaptation stand mainly at the core of earlier theories. Someof the most fundamental concepts are those of appraisal and coping(Lazarus and Folkman, 1984). According to psychosocial theoriesof adaptation, when in contact with a new event, human beingsquickly engage in a process of categorizing that event with respectto its significance for their well-being, a process that is calledcognitive appraisal (Tomaka et al., 1993). Humans then respondwith a series of activities undertaken to master, tolerate, reduce,or minimize those threats or potentially harmful situations. Thesebehaviors are called coping responses in the psychosocial literature(Folkman and Lazarus, 1985).
The cognitive appraisals that anticipate the coping responsescan occur along a continuum of threat to challenge perceptionsof the external event. Threat appraisals suggest potential dangerto one’s well-being or self-esteem, whereas challenging appraisalslead individuals to perceive the possibility of gain from the situation(Skinner and Brewer, 2002). Whether individuals perceive the situ-ation as a threat or as a challenge depends on their judgments aboutthe extent to which situational demands are perceived as within oroutside their own resources or ability to cope with the demandsof the situation. These judgments, in turn, depend on a two-stageprocess of appraisal, including first primary appraisal and then theso-called secondary appraisal (Lazarus, 1966).
Primary appraisal concerns the positive or negative signifi-cance of a situation for a person’s well-being. Secondary appraisalrelates to the ability to handle the situation with success relyingon the resources at a person’s disposal (Scherer, 1999; Lazarusand Folkman, 1984). Given this, threat appraisals are those inwhich the perception of harm exceeds the perception of abilitiesand resources to cope with the situation. In contrast, challengeappraisals are those in which the perception of harm does notexceed that perception of ability to cope with the event (Tomakaet al., 1993).
Psychosocial researchers have also found two fundamentalforms that people use to cope with (i.e., respond to) stressful sit-uations, despite seeing them as challenging or threatening (Coyneet al., 1981; Lazarus and Folkman, 1984). One of these coping strate-gies is termed problem-focused coping, also labeled primary copingby some researchers (e.g., Rothbaum et al., 1982). In the same line,the other strategy is known as emotion-focused or secondary cop-ing.
Primary coping refers to the actions that people take with thegoal of removing or circumventing the sources of stress in the situ-ation. This coping strategy comprises active oriented behaviors tosolve the situations, including exerting more effort at a task, andbeing more resilient and assertive, effectively using one’s socialskills, paying more attention to the behavior of one’s interactionpartner, as well as cool, rational, deliberate efforts to solve the prob-lem (Folkman et al., 1986; Mallett and Swim, 2005). Secondarycoping, on the other hand, is related to the attempt to reduce oreliminate the emotional distress associated with the stressful sit-uation. This coping strategy includes accommodative and passivebehaviors such as accepting what is happening with resignation,denial of the situation, escape through fantasy, and ‘going with theflow’ (Scheier et al., 1986). In short, primary coping attempts tochange the environment so that it conforms to one’s needs, whereassecondary coping tries to adapt the self to the environment (Mallettand Swim, 2005).
Both common sense and scientific research usually express
some prejudice against secondary coping because it reflects a pas-sive and accommodative set of behaviors not directly aimed atproblem-solving in difficult situations. Some see secondary cop-ing as a preparatory stage for the more rational primary coping
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e.g., Scheier et al., 1986). But from an adaptive point of view, sec-ndary coping is as important as primary coping, a fact that isarticularly clear when one thinks of situations where one can-ot directly control or intervene in the environment (such as,
or instance, a severe economic crisis or an uncontrollable finan-ial markets performance). For example, research on the adaptiveechanisms of cancer-diagnosed patients has shown that engaging
n secondary coping strategies can help people to overcome stress-ul uncontrollable adverse events. Both before and after a cancerurgery, coping strategies such as acceptance, positive reframing,ecourse to religion, and the use of humor, have been found toeduce the levels of stress (Carver et al., 1993). Thus, more impor-ant than preaching the benefits of a certain kind of response toxternal stressful events, it turns out to be more interesting toetter understand when it is that each of the adaptive responseatterns emerges.
.2. Current state of research on expectations and copingesponses
Among the most researched psychosocial predictors of copingesponses are optimistic and pessimistic expectations toward theuture. Most of this research argues that optimistic expectationsre positively related to primary coping strategies (Aspinwall andaylor, 1997; Scheier et al., 1986). Social psychologists have definedptimism as the generalized belief that good things will happen inhe future (Scheier and Carver, 1985). Optimism has been foundo positively relate with several primary coping strategies suchs active coping, planning, and deliberate seeking of social andmotional support (Scheier et al., 1994). This relationship betweenptimism and primary coping can be explained by the well knownelf-control theory (Carver and Scheier, 1982), according to whichptimism leads individuals to believe that further efforts can beseful to attain their goals, leading them to take more active stepsnd engage in more active coping because their efforts are per-eived as productive.
Pessimism, on the other hand, was first associated with passivitynd accommodative behavior, relying mostly on secondary copingtrategies (Bryant and Cvengros, 2004; Malloy and Fyfe, 1980). Thisight explain why optimistic people usually show higher achieve-ent, increased perseverance, and greater work motivation among
ther outputs, than do pessimists (Carver et al., 1993).But the relationship between optimism/pessimism and coping
trategies has not proven to be as straightforward as it first seemedo be. First, recent studies have clashed with the idea that pes-imistic individuals are necessarily passive and engage mainly inecondary coping. Studies have found that more pessimistic indi-iduals can, at least in some situations, also evidence better positiveutcomes such as academic achievement, supportive friendshipetworks, and progress toward personal goals – active behavioralutputs that would be predicted chiefly by primary coping (Noremnd Chang, 2002).
The most credited explanation for this has been that those whoiew a situation in a pessimistic way are more prone to preparen advance for the adversities of the future, searching in an antic-patory manner for the resources and solutions that they mightater need for solving the problems and burdens they expect toace (Held, 2004). Peterson and Chang (2003) have synthesizedhis explanation by asserting that pessimists probably use theiressimism as a strategy to think about potential negative conse-uences as a means to self-motivate toward proactive behavior. Inhe same line, Lopes and Cunha (2008) have recently found that
essimists become less passive when they foresee potential actionoutes, and suggested that pessimists might discard their passivitynd start to act when they perceive that they are in a difficult situa-ion and need to devise plans to overcome the adversities. All in all,onomics 40 (2011) 652– 659 655
these recent findings suggest that in certain situations pessimistsare able and eager to engage in active coping.
Second, the relationship between optimism and coping strate-gies is not straightforward because recent research has also shownthat optimism does not always lead to primary or active coping.For example, in a field study using the Y2K millennium bug prob-lem, Aspinwall et al. (2005) found that some optimistic individualsshowed accommodative, secondary coping strategies. Particularlywhen damage estimates were perceived as high, those who wereoptimistic did not become active in trying to overcome the prob-lem, such as stocking several days’ worth of food and water in anunderground shelter or making copies of their PC’s hard disk. Onthe contrary, those who were optimistic responded in these con-ditions with accommodative and secondary coping strategies (i.e.,changing the understanding of the situation rather than initiatingdirect and personal actions to try to change the situation). Thus,when the situation is perceived to be uncontrollable, optimists aremore likely to disengage from active problem-solving and acceptthe situation more passively.
3.3. A general psychosocial model of human adaptation
The knowledge accumulated over the last years in the field ofsocial psychology regarding the core human adaptation mecha-nisms can thus be integrated in a general model that relates thesedifferent adaptation strategies with individual expectations towardthe future. The representation of that general human adaptationmodel is presented in Fig. 1 and can be described as follows.
When challenged by controllable events, optimistic individualsengage in problem-focused and primary coping strategies, evidenc-ing high proactivity levels. In the same kind of events, pessimisticpeople reveal a high propensity to passive behavior and anomie.When facing more uncontrollable situations though, the copingstrategies of optimistic and pessimistic persons seem to reverse.In perceived uncontrollable events, pessimism serves as a triggerto reduce passivity, somewhat increasing problem-focused coping(Lopes and Cunha, 2008), whereas optimism leads to a disengage-ment from active problem-solving and to a passive acceptance ofthe situation (cf. Aspinwall et al., 2005; Scheier et al., 1986). Sim-ply put, optimism is not always the driver of action that many pasttheories have considered it to be. In certain contexts such as thoseof major turbulence and instability that lead to a perceived lowexternal controllability, pessimism seems to be the key to makepeople appraise events as challenging and lead them to engage inproblem-focused and primary coping.
A direct link to how this model matters in explaining how peoplereact to different economic environments (namely, controllable vs.uncontrollable and expanding vs. contracting economies) is quiteevident and will be further discussed below. But the widespreadassumption that the optimism of economic agents is necessarilya driver of investment, innovation, and entrepreneurial proactivebehavior assumed by several leading economists (e.g., Andersonand Goldsmith, 1997; Katona, 1979, 1968; Keynes, 1936) mightneed to be complemented with a contextualized moderation.
4. A psychosocial explanation for economic cycles
As said at the beginning of this paper, among the critical vari-ables that Katona considered were the optimistic expectationstoward the future and confidence vs. the pessimism and uncer-tainty expected regarding external environments (Katona, 1979).
However, reconsidering Katona’s assumptions in the light of therecent findings on social psychology revised above and of the modelpresented in Fig. 1 of this paper, one must revisit his assertionsthat pessimism is necessarily associated with uncertainty. In the
656 M.P. Lopes / The Journal of Socio-Economics 40 (2011) 652– 659
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ame way, one must also accept that the linear positive relation-hip between positive consumer expectations (i.e., optimism) andonsumer active behavior (i.e., purchasing) might be moderatedy other contextual variables, such as controllability and contextredictability.
As such, it seems clear that the model presented herein helpso complement and increment these earlier works and our under-tanding of consumer behavior and the economic cycles. Researchn psychology has greatly improved in the last decades concerninghe major psychological predictive variables of aggregate consumerehavior such as optimism and perceived control. Given theseevelopments described above, I can thus propose an explana-
ory model for economic cycles based on a social–psychologicalerspective. The model is graphically represented in Fig. 2.Because there are regularities in the factors of growth, such ashanges in population demographics and in savings and accumu-
Fig. 2. An elliptical model of human adap
odel of human adaptation.
lation, so does the economy follow its “natural” and endogenouscyclical route, which according to the majority of models occur ina 4-phase cycle of (1) prosperity, (2) recession, (3) depression, and(4) revival (Kuznets, 1940).
The model considers an elliptical form to describe how aperson’s optimistic and pessimistic expectations as well as herperceived controllability/uncontrollability over external events canhelp to describe the patterns of human adaptation during the fourtraditional phases of economic cycles. The use of an ellipse stressesthe existence of turning points, both for the upswings and thedownswings. This is congruent with research that has found theempirical evidence of these turning points at the consumer sen-
timent level (Katona, 1971), and is consistent with the economiccycle literature.The model’s dynamics can be described in the following way.When at the top of optimism, and because people perceive their
tation through the economic cycles.
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ocio-economic environment as somewhat predictable and con-rollable, they engage in active coping and they achieve productiveevels and profitable initiatives, such as entrepreneurial activitiesnd spending. At this stage, power structures have developed andrystallized and creative social learning gives way to incrementalroblem-solving. Bugs have been eliminated and processes obtainheir maximum efficiency, but motivation starts to level off ashallenges are reduced (De Greene, 1988). Because positive expec-ations are at their maximum, at some point the achieved resultsan no longer correspond to those expectations and expectationstart to become more negative. Because, as we have seen, economicerformance appears with a lag of about 6–9 months, this corre-ponds to the prosperity phase of the economic cycle, as economicerformance is reflecting previous highly optimistic expectations.
So at first, people are obtaining positive results, but as theirositive expectations rise, prosperity levels become unsatisfactorynd pessimism and frustration start to take over (Rötheli, 2010).nce more, given the time lag between sentiment and its impactn performance, economic performance soon decreases, reinforc-ng even further people’s pessimistic expectations. At the sameime perceived uncontrollability over one’s environment increases,s things start not to function as they used to in prosperousimes. In this context, as predicted by the model and psychoso-ial research, people start to disengage and adopt passive copingtrategies. Because of this passive behavior a recession sets in,xacerbating the pessimism and perceived lack of control. This isongruent with earlier empirical results indicating that “when aerson is uncertain about the future or is disappointed becausee is unable to accomplish what he wishes, the process of adapta-ion consists of scaling down his aspirations (. . .). The extreme caseonsists of resignation and the stifling of wants.” (Katona, 1968,. 21).
However, as pessimism increases in the face of perceived uncon-rollability and poor economic performance, it leads to a changen coping. As confirmed by several studies from social psychologyeviewed above, in this situation people draw on active coping andtart taking action to try to solve their problems. The above citedork of Lopes and Cunha (2008) is again relevant at this point.
hese authors found empirical evidence supporting the idea thatessimistic people will engage in alternative actions as a form ofesponse to perceived uncertain environments. So, whereas I wouldgree with Katona (1968) that people scale down their aspiration inhe face of uncertainty, I argue that it will happen only for optimisticeople. When people are pessimistic, on the other hand, uncer-ainty promotes the emergence of new and alternative aspirationss an adaptation strategy, such as finding a second job or starting aarallel business. Because these psychosocial adaptation behaviorso not result in an immediate change in the economic performance,
t occurs during the depression phase of the economy. This is con-istent with some authors’ assertion that in the depression phaseeople feel that there is nothing to lose by trying out new ideas andhis, in turn, increases activity at both the consumer and producerides (De Greene, 1988).
Eventually, the proactive actions undertaken by pessimisticeople in the depression phase start to obtain results, along with
low and negative expectation toward economic performance,eading to an increase of both optimism and relatively positiveconomic performance, ushering in the recovery phase. Of coursehis transition is not immediate and pessimism is hard to over-ome, most of all because at some stage pessimistic people start toerceive some control over the events and disengage from activeoping. As some have stated, “optimism and pessimism of the
asses tend to change slowly” (Katona, 1979, p. 125), but at someoint they both can eventually be defeated and give rise to theubsequent wave of prosperity, led by highly optimistic individu-ls coping proactively as they perceive their new economic reality
onomics 40 (2011) 652– 659 657
to be predictable and controllable. Coming from the last recoveryphase, people experience a new sense of hope that makes them feelhighly motivated and willing to try new approaches. Alienation andanomie are low and problem-solving is creative. People can againfeel the entrepreneurial spirit (De Greene, 1988), bringing againeconomic prosperity.
The analyses of economic cycles based on these recent develop-ments in psychosocial theories of adaptation bring new insightsand policy implications that will be discussed in the conclud-ing section. For now, I wish to stress that the model developedhere complements previous studies on the role of human adap-tation mechanisms toward different economic settings that werebased on a positive bias toward the positive value of optimisticexpectations concerning the future and a negative prejudice ofpessimistic expectations. As recent research has shown, optimismleads to passive coping in certain situations, whereas pessimismmight promote primary coping action at other moments. The modeldeveloped in this paper therefore brings a major contributionto existing psychoeconomic theories of economic development,which have usually overlooked the role of negative expectationstoward the future or have considered them as simply a bad indica-tor.
5. Conclusions and implications
Economists have long recognized the importance of positive andnegative expectations on the behavior of the economy as a whole(Keynes, 1936; Schumpeter, 1939; Smith, 1759). However, recentdevelopments in the field of psychology and social psychology havemade it possible to increase our knowledge of concepts such asoptimism, pessimism, and perceived control over external events,as well as lead to the development of more integrative psychosocialmodels of general human adaptation. This is the main contributionof the present paper. After revising this novel literature, I have pro-posed an integrative model that social scientists can apply to thestudy of human adaptive behavioral patterns.
A major conclusion that is derived from the proposed model isthat optimistic expectations do not always lead to higher economicdevelopment, but depend on the phase of the economic context(upswing or downswing). In fact, in certain economic contexts (e.g.,during an economic downturn) pessimistic expectations should bea better positive predictor of how fast the economy will recoverin the aftermath. It seems useless to communicate an optimisticoutset when the context is one of uncertainty. In those situations,it is better for people to become pessimistic in order to become lesspassive and start to take action to improve their economic situation.
This particular finding is of utmost importance to advance the-oretical perspectives of economic and business cycles that haverelied exclusively on the assumption that generalized positiveexpectations are always in the best interest of economic develop-ment. In fact, this is somewhat counterintuitive and often has notbeen taken into account in earlier models of economic develop-ment.
I am not saying that previous models were wrong, but insteadthat they function primarily in perceived controllable environ-ments. Normally, i.e., when there exists a “controllable sentiment”among economic agents, expectations impact investment behaviorin the way predicted by economists like J.M. Kaynes, for instance,who asserted that expectations drive investment in a forwardlooking way much more than the observations of past events do(Anderson and Goldsmith, 1997). That explains why Katona (1968)found evidence that expectations are relevant in understanding
how households’ consumption decisions over durables, and thatpositive expectation is the one driving consumption. The modelproposed here is consistent with these previous models and pre-dictions.
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However, considering that human behavior patterns reversen times of perceived uncertainty and controllability adds valueo these explanations, it helps to explain some previous findingshat did not fit those monotonic models. For instance, the modeldvanced in the present paper allows one to better understandhy pessimism dispelled uncertainty around the year of 1974 inatona’s (1979) data analysis. In fact, it would be difficult to explainow economic development would turn around after a setback ifne does not assume that pessimism could play a role in stimulatingonsumption.
So again, the model proposed here does not go against previ-us models of economic development. On the contrary, it allowss to reinterpret the results obtained when testing those previousodels (i.e., that they function well in times of perceived control-
ability) and expand the explanations by incorporating a way tonterpret also the events that do not fit those models (i.e., that aessimistic outlook is, at times, the key element for consumption,
nvestment and economic development). As a result, this paperakes a significant contribution to this literature.In addition, and probably also as a consequence of this theo-
etical misassumption, policy-makers and financial experts suchs those responsible for monetary-policy management have alsoased their decision-making on an imperfect model of economicevelopment. This conclusion has clear implications for economicnd financial policies. One of the implications is that authoritieshould seek to promote the perception of controllability by eco-omic agents over the economic environment. For central banksnd similar authorities, price stability has been, in fact, one of theajor goals of their policies and actions (Mayer, 2008).However, by aiming to achieve price stability they often imple-
ent actions that trigger even higher levels of instability in otherocioeconomic dimensions. As for instance De Grauwe (2008, p.58) remarks concerning how central banks act on the edge of aerceived economic downturn, “agents interpret a decline in the
nterest rate as signaling future inflation. As a result, inflation actu-lly increases forcing the central bank to raise the interest rate.his produces a stop–go policy that destabilizes output, inflationnd stock prices” and seems to play a critical role in inducing assetrice bubbles (Mayer, 2008). Some have recently also noted that theases of “policy making adding to uncertainty and instability haveot been confined to the U.S.” but spread worldwide, particularly
n Europe (Rötheli, 2010).Clear evidence of policy insensitivity to this issue is the neglect
n measuring controllability perceptions by authorities. Measuresf consumer sentiment have gained their correct importance andre today thoroughly followed, but a systematic measurement oferception of control or “controllability sentiment” is still in needf attention. Future research should thus seek to determine theptimism and controllability thresholds at which people start tongage in more proactive coping behaviors, including consumernd investment decisions. To achieve that, authorities must mon-tor perceived controllability as much as they already monitoronsumer sentiment. Making-decisions informed by the controlla-ility sentiment as much as by the consumer sentiment and otherconomic indicators is a clear and important implication for mone-ary policy-makers, particularly for those managing central banks.
In addition to financial policy implications, the conclusions ofhis paper should also impact general economic policy making.atona (1980, p. 33) found, for instance, that during the recessionf the 1970s the index of consumer sentiment “correlated muchore strongly with people’s confidence in the government’s eco-
omic policies than with past price movements”. This is in line with
he model proposed in the current paper, which stresses the impor-ance of controllability and the consequent confidence of citizenss a major leverage of positive economic development.onomics 40 (2011) 652– 659
Given the novel contribution of the model proposed on thispaper and the counterintuitive character of some of its assump-tions, several criticisms might be raised. A relevant point is thatof whether optimistic/pessimistic expectations are adequate toexplain how people adapt to economic changes given the long-lasting nature that these psychological traits evidence in someresearch. A review of the psychological literature on this topic, how-ever, shows that optimism can be conceived as either a trait or astate. Firstly based in the work of Scheier on dispositional optimism(Scheier et al., 1994; Scheier and Carver, 1985), the study of opti-mism has recently been approached as a state-like psychologicalcharacteristic. The work of Peterson and Seligman on the explana-tory style hypothesis and the writings of Seligman on learnedoptimism and learned helplessness are other relevant examples(Peterson and Chang, 2003) evidencing that beyond relatively indi-vidually stable psychological traits, peoples psychological states dochange according to external conditions. Even an individual with anoptimistic personality will lower that optimism in the face of hardeconomic perspectives. It is relative to this variability in psycholog-ical states that researchers should interpret changes in optimismand perceived controllability.
Another significant issue is that of whether an individual-leveladaptive response can generalize to a macro-societal level of adap-tation. This should let us turn to the classic conjectures of Smith(1759) on how individual action produces macro-level social andeconomic behavior. Although these relations between individual-collective behavior are complex and must be considered withcaution, only an empirical test of how generalized these modelsfirstly developed at an individual and psychological level can be toa macro-societal level.
At this point, this relates to the final important issue of conclud-ing if the model proposed in this paper actually explains economicbehavior beyond other relevant variables such as poverty, wagediscrimination, household problems, bankruptcy and many othervariables. This issue also relates to the current fashion topic ofmultiple equilibria in economic theory (e.g., Hillier and Rougier,1999). Although these are very important points, we leave furtheradvancements of predictions based on multiple equilibria for fur-ther studies. If accepted at this stage as a worthwhile model, themodel presented in this paper will ultimately raise new empiri-cal questions which only future research will allow answering. Theincorporation of the variables considered in the model presented inthis paper will, in future research, allow for the test of the influenceof each of these different variables.
In sum, I have shown that the recent developments in socio-psychological research concerning the adaptive human processesto different uncertainty contexts can be extremely informative asto how people will react to different economic situations. I haveparticularly predicted that optimism will not always positivelycontribute to economic growth, and that in certain situationspessimism is the mindset that will positively contribute to makepeople become entrepreneurial and proactive in finding newsolutions for the adversities they face and, thus, contribute toeconomic recovery. There seems to be no doubt that “the notion ofstages of wide-spread over-optimism in expectations followed byover-pessimism has been part of economics for years” (Leiser andRötheli, 2010, p. 117). But an integrated model that simultaneouslyexplains how optimism and pessimism are complements in theeconomic cycle was still missing. That was the core goal of thispaper.
I hope this leads economists to revise traditional and mono-tonic economic explanations for economic and business cycles
and encourage policy-makers to shift from the assumption of“positive expectations increase” into the paradigm of “expec-tation management”, which would have to incorporate an
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ncertainty/controllability measurement along with the somehownstitutionalized optimism/pessimism axes.
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