On the Economy—Understand the "Irrational" Where did our financial institutions go wrong? Many accounts focus on greed, fear, and lack of trust. And why did things get so out of hand? Why was there a housing "bubble"? Somehow, "irrational exuberance" (Robert Schiller) or "animal spirits" (John Maynard Keynes) overwhelmed rational calculations of risk and reward. And it isn't just that irrational optimism, or even blindness to market fundamentals, gets the better of our rational faculties. Rather, as George Soros has pointed out, these psychological phenomena can become part of a feedback loop that actually changes market fundamentals. "Reflexivity," he calls it. The housing bubble was not the first such phenomenon, nor will it be the last.
Economists offer little that helps us understand why such bubbles occur or how they might be prevented. They also have little to tell us about how to prevent a "downward spiral of negative expectations" that makes fear of an economic downturn self-fulfilling. Economists largely make assumptions about the rationality of human decision-making and proceed from there. Witness Alan Greenspan's recent admission that he was mistaken in assuming that markets operate rationally and efficiently. The current crisis makes it clear that ignoring the real psychology of greed, fear, trust, and irrational enthusiasm (0r pessimism) can be perilous. Economists offer little that helps us understand why such bubbles occur or how they might be prevented. A Council of Psychological Advisors could help.
Wednesday, January 7, 2009
Presidential Council of Psychological Advisors ?
Barry Schwartz writes;