Consumer's Psyche Pushed to the Economic Fore

Tuesday's tragedy presents many economic obstacles. But observers are confident the economy will persevere.
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Among the many reverberations felt in the aftermath of Tuesday's terroristattacks on the World Trade Center and the Pentagon are heightenedfears about the impact on the consumer, who has propped up the

weakening U.S. economy.

"The big question everybody's asking is: What's going to be the impacton consumer spending and consumer psychology? The reasonable best guess isit will be negative; the only question is how negative," says Robert Litan,director of economic studies at the Brookings Institution. He believes thelatest events, coming on top of last week's news of a sharp spike in

unemployment, may give further impetus to Fedrate cuts, possibly even prompting an intermeeting rate cut.

Some market watchers are speculating that safety-conscious consumersare likely to curtail spending -- hurting the retail sector -- and may alsocurb nonessential travel in the near term, potentially hurting industriessuch as airlines, hotels and restaurants. However, while history indicates thattimes of crisis -- the Iraqi invasion of Kuwait being a recent example -- dohave a material near-term effect on the consumer, economists say that theydon't expect to see a long-term economic impact from the attacks, even ifthe memories linger.

"Clearly there are short-term disruptions that are quite material --there's noquestion about it when you have that kind of impact in the middle of theFinancial District. But this is not an economic event. It's a devastatingnational security and defense issue, and it will be dealt with that way,"says Glenn Yago, director of capital studies at the Milken Institute, anon-profit economic think tank in Los Angeles. "The real

U.S. economy isrobust, relative to the rest of the world."

The Near Term

Economists expect consumers to grow even more cautious, at leasttemporarily.

"This will exacerbate the trend of people tightening theirbelts and reducing spending, at least in the short term," says JoelSlemrod, a professor of economics at the University of Michigan's businessschool. "That's generally what people do when there's uncertainty; they tryto store up their savings."

Even before the attacks, retailers had given significant warnings aboutmuch more modest growth expectations in the third and fourth quarters, withmall traffic extremely slow in the last two months.

Jennifer Black, aretail analyst for Wells Fargo, says she has "low expectations" for thesector. "People will keep their money even closer to the vest now. Fear,uncertainty anddoubt tend to curtail spending."

The Kuwait Parallel

In recent history, perhaps the closest parallel that can be found isthe Iraqi invasion of Kuwait in August 1990.

The invasion had a significant effect "because of the consumer

perception that we were going to war and the effect of rapidly rising gasprices," says Richard Curtin, who directs the University of Michigan'sconsumer surveys, including the Survey of Consumer Confidence. The Iraqiinvasion did considerable damage to consumer confidence, with the sentimentindex dropping 25 points from July to October 1990 -- a time period thatincluded the largest-ever one-month drop in consumer confidence.

To put that into context, in response to the slumping economy lastwinter, the sentiment index fell by a similar amount, about 20 points,between November 2000 and February 2001. Since then it's little changed.

Curtin expects to see a drop in consumer confidence in response to theattacks in New York and Washington, and that's likely to translate intolower consumer spending. But even if confidence drops somewhat, the mostrecent sentimentreading in the low 90s "is still quite favorable," he points out. "We'dthink of consumers slowing their pace of spending but not outrightrecession." The September survey will be released on the 28th of thismonth.

Hopes for Optimism

In contrast to the situation leading up to the Gulf War, it appearsU.S. consumers today will not have to fret about oil shortages. The priceof crude oil dropped Wednesday after an initial spike upward following theterrorist attacks, with the American Petroleum Institute emphasizing thatU.S. gasoline and diesel fuel inventories were adequate.

Also on the plus side, in the wake of the recent attacks U.S.politicians have so far presented a united front in seeking to punish theperpetrators of the terrorism. That's a marked contrast from the periodbefore the Gulf War, when investors were unsettled by the bitter divisionin Congress over how to respond to Iraqi aggression.

For good or ill, economists say consumer confidence in the near term islikely to reflect the decisions of federal policymakers. "Will reaction onthe national security angle be quick, and if there's a fiscal stimulus,will it be quick? Any decisions that would be prompt and reflect a strongconsensus would help bolster consumer confidence," says the BrookingsInstitution's Litan.

"I hope we can be optimistic, if the morale I sense in the addresses ofCongress and the president and what I hear in the street translates intothe stock market," says Meir Statman, a behavioral finance professor atSanta Clara University in California.

Still, any short-term morale-boosting effects are likely to be subsumedby more enduring worries about the underlying state of the economy andrising unemployment. "Of course there are other things to do with theeconomy quite independent of this," says Statman. "When people lose theirjobs, they don't have money to spend."