the visible hand

it is the theory which decides what can be observed – einstein

irrational self-interest…

Posted by ecoshift on November 2, 2008

Interesting article from Robert Shiller, the Yale economist responsible for the widely followed Case-Shiller housing price index, in today’s NYT. He brings up how psychological factors — desire to be perceived as part of a given consensus and concern for one’ s professional reputation — can lead experts to soft pedal their concerns about policy decisions. On the one hand, this is rational self-interest in action. On the other hand rational professional observations and conclusions were swept aside to allow irrational behavior in the market place to significantly impact market efficiency. After all, who wants to be known as Dr. Doom?

But there is a more fundamental question here. Economic theory is dependent on the assumption that people act rationally. That individuals allocate their economic resources according to an informed and rational assessment of how it effects their own interest. Yet, few of us will have to look outside our own extended families to find examples of economic resource allocation guided by a range of values that extend well beyond, or are irrelevant to, rational informed assessment of the potential for personal gain.

The current crisis offers an important opportunity to reassess the fundamentals of economic theory to account for the range of values that guide individual choices. Thanks to Mr Shiller for articulating his doubts even as he does so in a relatively “formal way that conforms with apparent assumptions held by the group.”

Economic View – Challenging the Crowd in Whispers, Not Shouts –
Challenging the Crowd in Whispers, Not Shouts
Published: November 1, 2008

ALAN GREENSPAN, the former Federal Reserve chairman, acknowledged in a Congressional hearing last month that he had made an “error” in assuming that the markets would properly regulate themselves, and added that he had no idea a financial disaster was in the making. What’s more, he said the Fed’s own computer models and economic experts simply “did not forecast” the current financial crisis.

Mr. Greenspan’s comments may have left the impression that no one in the world could have predicted the crisis. Yet it is clear that well before home prices started falling in 2006, lots of people were worried about the housing boom and its potential for creating economic disaster. It’s just that the Fed did not take them very seriously.

For example, I clearly remember a taxi driver in Miami explaining to me years ago that the housing bubble there was getting crazy. With all the construction under way, which he pointed out as we drove along, he said that there would surely be a glut in the market and, eventually, a disaster.


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