The Macroeconomic Consequences of 9/11

Much has been written about the macroeconomic consequences of the tragedies in New York, Washington and Pennsylvania, and most of this has to do with shattered consumer confidence and the consequent reduction in spending. There are two common measures of consumer confidence, both indexes updated on a monthly basis. One is produced by the Consumer Confidence Board, a non-profit business group; the other  is an index produced each month by the Universioty of Michigan. Both indexes are constructed in part from reponses to survey questions. Without a doubt, consumer confidence fell, and unemployment rose sharply, in the aftermath of the attacks. But the economic consequences should also be put into perspective: consumer confidence had already fallen, dramatically, and unemployment had already risen, in the months preceding the attacks. The economy was already in a recession.
The Recession of 2001-2002. Note that consumer confidence began fa lling, and unemployment began rising, at the beginning of 2001. Yes, the terrorist attacks on the United States did further damage to conifdence, but they exacerbated, rather than initiated, the recession.
Nonetheless, from the perspective of our analysis, the exact timing of the onset of the recession of 2001-2 is not important. At some point early in 2001, confidence fell, causing a reduction in consumer spending (and investment) for any given interest rate. That is, the IS curve shifted to the left. The government response is either (i) increase the money supply, lowering interest rates, and inducing a countervailing shift in the LM curve; (ii) raise government spending and cut taxes to shift the IS curve back from whence it came, or (iii) do both. Brad de Long suggests that both might be necessary. His arguments should remind you of recent debates about government policy in Japan.

On Line Readings
Terrorist Attacks and Consumer Confidence
Brad DeLong on the Government's Response