Have you ever wondered if the economy is influenced by our expectations? What I mean to say is, if we all believe that the economy will be great next year at this time, might such beliefs - coupled with actions consistent with them - become self-fulfilling? Might our expectations about our economic future actually operate to create it?
I hasten to inform the reader that I don't really know anything about economics. I might have attended three or four class meetings of the obligatory Econ 101 & 102 courses I completed as an undergradate. When did attend, I was usually under the influence of intoxicants. Still, I have wondered - for quite a long time - if fears about the economy, taken together with negative talk, cut-backs on personal spending and investment, etc... might fuel or actually create economic downturns. Could it be that we actually make a horribly uncomfortable nest and then sleep fitfully in it until we begin to have happy thoughts about our financial future? If so, is it rational to believe that when that happy day dawns, a virtual explosion of home remodeling, new-business start-ups, and brisk retail sales will result?
A key word in the preceding sentence is "rational". Since my college days many moons ago, I have learned that some economists believe that people make financial decisions - both business and personal - based upon what they rationally expect to happen in the future. In freshman economics textbooks the theory is called the "theory of rational expectations".
Using a hypothetical, let's investigate this notion of rational expectations and see if it makes sense. Consider, for a moment, the hypothetical case of Benny Juarez and Alan Smiley:
A superb football player, Benny attends USC on a "full-ride" athletic scholarship. The scholarship is great and Benny loves football, but he could readily have obtaned an academic scholarship. Benny was Valedictorian at Holy Cross High School in Albuquerque, NM - an institution recognized for tough academics and a great football program. Benny is the best running back in the NCAA, and he just capped off his junior year by winning the Heisman Trophy and leading the Trojans to victory over Oklahoma in the Rose Bowl. The win was especially sweet because the National Championship was on the line. If Benny enters the NFL draft, he will probably be picked first. Consequently, he is positioned to earn an enormous salary and have a great life.
Alan attended an undistinguished public high school in Anthony, TX where he graduated No. 78 in a class of 99. Alan prepared "a little" for his SAT, and his scores reflected the "little" effort he expended. Turned away by several colleges, Benny finally gained "provisional" admission to Eastern New Mexico University in Portales. Unlike Benny, Alan has just completed his freshman year. With a GPA of 2.1, the academic death penalty (academic expulsion) dangles above his goofy head like the Sword of Damocles. Alan set out to declare a major in accounting, but after earning a "D" in his first accounting course, he's planning to major in Art History with an emphasis in Film. His buddy "Yoder" is a Film major and reports that the program is "easy beans". He claims that he gets easy "A" grades for watching old Bruce Lee movies. This sounds pretty good to Alan who considers that the bizarre lady who chairs the department might take a favorable view of early UFO flicks given the university's close proximity to Roswell.
In a strange twist of fate, both Benny and Alan attend a Felowship of Christian Athletes conference in Dallas (Alan because he is on the ENMU Bowling Squad). While they are there, they are both approached by a recruiter from the U.S. Army. Both are informed that just with a few, easy, ROTC courses under their belt, a summer camp, and a few other small requirements completed, that they could be commissioned as Second Lieutenants upon graduation. Officers! He goes on to provide a complete - and impressive -account of all the benefits that accrue to the fortunate few who are smart enough to sign on the dotted line!
Benny expects to enter the NFL draft and earn millions. He is also an Academic All American with a 4.0 GPA in molecular biology. When his football career ends, he plans to pursue graduate study in moluecular biology and begin a second career as a research scientist in the field of oncology. Consequently, he politely declines the government's attractive offer.
Alan, considers the offer carefully. In fact, he returns to the recruiter's booth and completes a battery of military tests. He is shocked to learn that he is not stupid at all. In fact, the recruiter informs him by telephone that the tests indicates very high mathmatical aptitude - especially for a field called cryptography. He tells Alan that if he will change his major to math, earn good grades and complete the ROTC curriculum, he will be invited to receive special training in cryptography after he is commissioned. Alan realizes that math has always been his best subject. Its the only subject in which he routinely earns "A" grades. He likes it and it comes naturally to him. He also recongnizes that his life is going nowhere. He realizes that he has never really tried to do well in school. He knows he isn't stupid - just bored. Coming from nowhere, from a household where negativity prevails, and education is criticised as "useless as teats on a boar hog", Alan knows he will never again find an opportunity as good as the one being offered by the recruiter. He sees that he is being offered a chance to get out of the wretched little burg where he was born and be trained to do a serious, important job. A job that really matters. He calls the recruiter and makes arrangements to sign up - its the most exciting day of his life.
In this hypothetical, it may be said that both young men's expectations for the future are "dead-on". They are fully rational and they cut directly to their financial future.
Benny expects to be financially successful and his expectation is shared by every NFL franchise owner, coach, player, fan and sportswriter in the nation. He knows that his expectations might fail if he should play out his senior year at USC and sustain a career-ending injury. It happens often enough that Benny enters the draft and waves farewell to USC. His signing bonus is enormous and he immediately orders a Maserati and buys a 7,000 SF house in Aspen. He never thinks of the Army again as long as he lives.
No more than a handful of people have ever heard of Alan, but the U.S. Army is pretty sure that he will make a good crypto officer. The predictive value of their tests is quite high. Alan knows well enough that math comes easy to him. He even went to the ENMU library and found some books on the subject. He was was fascinated and he knew, intuitively, that he had found something he could do well.
The expectations of both young men were rational, they acted on them, and it is certainly believeable that their actions might play a role in creating their future.
How might this apply to consumer decisions like home remodeling? Well, the economy is undeniably in a shockingly bad condition. Does anyone really know for sure what's going on? Probably not. What we might rationally expect in the near term? Who knows? Funny, isn't it? Nobody really knows for sure, but consumer confidence is up - not by much, but it is rising steadily! Why? What could possibly explain such optimism? How should it influence what we think or do?
In the end, I think it all boils down to this: What do you feel in your gut? If you live in one of the neighborhoods where we often work, you already know that most people's expectations are remarkably positive. Most of us expect a turnaround by March or April of next year. We expect home prices to return to pre-recession levels over the next 24-36 months. Of course, home prices in East Sacramento, Land Park and other areas where we regularly work have not lost value to the extent that homes in other areas have.
There is no percentage in worrying about the economy on a national level. There are just too many variables and conditions specific to local markets to make blanket judgements about home prices and/or real estate over any broad area. Sure, we all want the country as a whole to do well and I think it will - sooner than later. But, from the perspective of a consumer and employee of a small business I think it makes much more sense to focus on our local market - not all of Northern California, not Southern California - not even the wider Sacramento metropolitan area - but, the six or seven zip codes where we live and work. I'm talking about central Sacramento. East Sac, Land Park, Midtown, Curtis Park, Carmichael, Fair Oaks and the Arden areas. [If you don't live in any of these areas, your expectations should probably hinge on the conditions peculiar to your particular neighborhood.] I expect home values to hold up well in coming days and to come back strong faster than most other areas. I think this is a rational expectation based upon personal observation and discussions with many homeowners (including our clients). Moreover, I beleive that remodeling makes all the sense in the world if you live in our market area. Besides, when you act on your expectations, you might just play a part in restoring our local economy to health.
I really welcome your comments, suggestions, thoughts - whatever! Let us hear from you.
Till next time...
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