After the Attack: Perspectives - Terrorism and Macroecomics: Suddenly U.S. Policy Makers are Galvanized

by Huw Pill

Stock markets may tumble and exchange rates gyrate. The NAPM index yo­yos, while the Commerce Department revises GDP and productivity growth. The minutiae of macroeconomic data are mulled over by economists on Wall Street and by policymakers at the White House and Federal Reserve, each continually refining his or her view of the prospects for the American economy.

For a few hours on September 11, this cycle of analysis, assessment, and revision came to an abrupt halt. The horrific scenes at the World Trade Center necessitated a pause. The enormity of the unfolding tragedy made it impossible for these economists to perform their regular work.

	Even the terrifying spectacle of the collapsing twin towers has had a negligible impact on America's productive and financial capacity.
	—Huw Pill

In the aftermath, as the nation attempts to return to some semblance of normalcy, minds have refocused on the economic implications of the tragic events of September 11. With America already suffering from serious macroeconomic imbalances and teetering on the verge of recession, were the terrorist attacks the catalyst for an American or global economic downturn?

Fundamental strengths
It was only in March—a short six months ago—that President Bush confidently claimed that "the American economy is like a great athlete at the end of the first leg of a long, long race—somewhat winded, but fundamentally strong." 1  Such confidence prevailed despite unfolding declines in the Dow Jones and NASDAQ indices. Perhaps unwittingly, President Bush's words echoed those of a previous Republican President. In October 1930, with the Wall Street crash less than a year old, Herbert Hoover argued that "the fundamental assets of the nation—the education, the intelligence, the virility, and the spiritual strength of our 120 million people—have been unimpaired." 2 

Ensuing events proved Hoover wrong. Financial crisis and a catastrophic collapse in confidence threw the U.S. into the Great Depression. Will the terrorist attacks trigger a similar response?

America's physical infrastructure certainly suffered as a result of the terrorist attacks. But even the terrifying spectacle of the collapsing twin towers has had a negligible impact on America's productive and financial capacity. Disruption to activity on New York's financial markets was short­lived, testimony to the organization and resilience of these sinews of the U.S. economy. The threat of financial crisis stemming directly from the terrorist attacks has been averted, thanks to the prompt action of the Federal Reserve, coordinated with other institutions in America and beyond.

Psychological weaknesses
Confidence is more fragile. Even prior to September 11, conventional measures of confidence were falling sharply. One can surely anticipate further weakness.

Returning to the Harvard Business School campus in February after two years in Europe, I was struck by the enduring optimism of our MBA students, despite the incipient economic slowdown. In the spring, I heard students who had failed to obtain their "dream job" during the recruiting period discussing the option of traveling for a year until the economy recovered in 2002. This undimmed optimism stands in marked contrast to the mood of the MBA class after September 11. Genuine concerns and uncertainty exist. While Harvard MBAs hardly constitute a representative sample, their concerns and fears reveal an underlying weakness in the American economy.

It has become commonplace to say that after the events of September 11 America will never be the same again. If the enduring strength of the American economy over the last century truly rests on the optimism, entrepreneurship, and dynamism of its people, the terrorist attacks have exacted a significant, though no doubt temporary, toll.

Terrorism of the mind
Franklin Roosevelt famously attributed the Great Depression to "nameless, unreasoning, unjustified terror which paralyses needed efforts to convert retreat into advance." 3  It is easy to dismiss our students' current fears as irrational, given that they will enter the job market with the not inconsiderable benefits of an HBS education and degree. But after September 11, many fears—including those that had previously seemed abstract or irrational—suddenly appear all too real. How do we now feel about flying American Airlines or working in high­rise buildings? What was part of our day­to­day existence has become a source of unease.

My own life has been touched by terrorism. One of my high school friends joined the Royal Marines on leaving school. He was among the members of the Marine band murdered by an IRA bomb in the fall of 1989. While the scale of this attack was modest by the standards of the recent atrocities, the impact on the families involved was catastrophic. Some have never recovered. Even for those, like me, who were much more peripherally touched by the tragedy, the mark was enduring.

Given the scale of the events of September 11—events that touched a whole nation and beyond—one should not underestimate their potential psychological impact. The perpetrators of terrorism prey not only on their immediate victims, but also on the minds of those left behind. The potential economic implications are immense.

Macroeconomics: individual fears, collective actions
Such concerns are real. They are already reflected in the emerging economic data. Yet macroeconomic considerations offer some reasons for guarded optimism regarding future economic prospects.

As a discipline, macroeconomics owes its existence to the view that aggregate behavior is not simply the sum of individual behavior. Real and psychological spillovers among the actions of individual firms and households mean that individual experience cannot simply be extrapolated to explain the dynamics of the economy as a whole. My own reaction to the impact of terrorism on my life cannot simply be multiplied to obtain the impact of September 11 on America.

Macroeconomics therefore allows a role for public policy. Policymakers looking at aggregate behavior can address spillover effects in ways individual firms and households, concerned with their own spending and investment decisions, cannot. While the terrorist atrocities may have triggered a collapse in private confidence, they have also been the catalyst for a prompt policy response. The Federal Reserve and other central banks have aggressively eased monetary policy in the wake of the attacks. Congress has put partisan differences aside to assemble a fiscal stimulus package.

Recent experience in Japan demonstrates that delayed or inadequate policy responses can allow self­fulfilling negative sentiment, deflation, and depression to take hold. Once entrenched, these forces prove hard to reverse. In America, the terrorist attacks—although tragic in human terms and economically costly—have galvanized policy makers. In their aftermath, U.S. economic policy appears better prepared to address the enormous macroeconomic imbalances facing America. By acting earlier and more aggressively, policymakers may prove better placed to head off deflationary forces than their Japanese counterparts.

Macroeconomics is—and will always remain—an uncertain business. With bombs falling in Afghanistan, consumer and business confidence on a knife's edge, and the excesses and imbalances born of the so­called New Economy still to be worked off, immediate economic prospects in America are not rosy. Looking beyond the next few months is fraught with peril. Yet America today—an America galvanized to maintain its economic strength to fight a prolonged war on terrorism—is a country better prepared to address the underlying macroeconomic weaknesses than the complacent, "head­in­the­sand" America that existed before September 11.

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Huw Pill is an assistant professor of business administration at the Harvard Business School.

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