ANN ARBOR—Since 1946, the University of Michigan Institute for Social Research (ISR) has conducted a monthly survey to assess consumer sentiment and economic expectations. ISR economist Richard Curtin, director of the Reuters/University of Michigan Surveys of Consumers, provides these reflections on what lies ahead.

Q. Just how bad off are consumers?

A. Most consumers now view their own financial situations quite negatively, providing the worst financial assessments we have recorded in the more than 60-year history of the surveys. Consumers started reporting their heightened financial concerns nearly two years ago, well before the start of the current recession. Unfortunately, in the past year the losses have been even larger, indicating that the cutbacks on consumer spending will persist through most of 2009.

Q. How did the downturn in consumer confidence start?

A. Spikes in gas prices and falling home prices came first, followed by declines in pension investments, accelerating job losses, and the freezing of credit markets. No one anticipated how serious each of these issues would ultimately become, not consumers, businesses, or even policy makers. Everyone thought that these problems could and would be quickly contained. This misjudgment had serious consequences. When improvement is expected to be just around the corner, the greater use of credit is appropriate, and everything from mortgages to credit cards were used to excess.

Q. How will the downturn end?

A. Most consumers know that the economy goes through cycles. Rising inflation and unemployment and the loss of confidence in economic policies have been repeatedly recorded in the past. Indeed, just like President-elect Obama, Presidents Clinton, Reagan, and Kennedy won their elections based in part on widespread discontent with the performance of the economy. And many expect that just as in the past, we will experience renewed growth under the incoming Obama administration. The trouble is that the extent of our current economic problems is so great that the eventual resolution will require consumers to spend less and save more than during the past two decades. This will slow the overall pace of economic growth for years to come.

Q. How so?

A. Consumers now recognize that they need to save more, for emergencies and unexpected events s well as to replenish their depleted retirement accounts. And consumers now recognize that credit will be more difficult to get, even after the current crisis is over. There will be higher credit standards, larger down payments will be required, and higher risk-adjusted interest rates will be charged. Consumers’ saving habits must change to a considerable extent, given that their savings rate recently fell to zero. As consumers increase their savings in the years ahead, they must decrease their spending. While greater savings and less credit use over the long term is certainly a good thing, in the near term it could cause a deeper and longer recession. This is what [British economist John Maynard] Keynes called the “paradox of thrift.” When everyone is trying to save more, they spend less, and the declines in sales and production mean less income, and those income declines mean that those savings goals are unlikely to be achieved.

Q. Could this result in a longer recession?

A. Consumers expect mostly good economic times interrupted occasionally with bad times. Typically, consumers expect recessions to be rather mild and brief, although many vividly remember the terrible recession in the early 1980s. As yet, consumers do not see their situation as completely hopeless. Indeed, the election of Obama was based in part on the expectation that new policies would ultimately resolve the economic crisis.

It still could be true that the economic hole is now so deep that we may not be able to quickly extract ourselves even with the best economic policies. It was the persistent and sharp rise in unemployment in the early 1930s that caused people not to defer their cherished dreams of a better economic life, but to abandon those dreams. The unemployment rate rose in only three years from just over 3 percent in 1929 to nearly 25 percent in 1932. The recent large increase in unemployment, if it continued to accelerate in the year ahead, could have the potential to cause such despair among consumers.

Such despair is not present as yet — it is the hope of Obama’s success that holds it at bay. To paraphrase what Winston Churchill once said about another crisis: we are not at the end of this crisis nor at the beginning of the end, but, perhaps, at the end of the beginning.

Q. What’s your forecast for 2009?

A. The outlook is especially bleak for the closing quarter of 2008 and the holiday shopping season. Credit purchases will be hardest hit, but the downturn will encompass every spending category. Overall personal consumption expenditures are likely to fall by just over 1 percent in 2009, making it the worst year for consumer spending in the past half century. This assumes that the new economic policies of the Obama administration are successful and the recession ends in late 2009. Deeper and more persistent declines in spending are possible if the free-fall in employment is not soon contained and the normal flow of credit is not restored.

Richard Curtin