The Rise of Behavioral Economics

At this time, not much is going to change the fact that the U.S. economy will recede to recession.  It makes sense considering that the U.S. economy is consumer driven and J.P. Morgan is forecasting some pretty week retail numbers for the U.S. fourth quarter.

Behavioral economics will only gain in popularity because of what is now happening in the U.S. economy.  Anyone who trusts the efficient market hypothesis has to be asking themselves right now why it took forever and a day for us to figure out that asset values (of homes) were nowhere where they should have been.

I believe many of the answers regarding the sluggish realization of asset prices in the stock market (we knew of dropping values back in the summer of 2007) and reaction to market shocks that we should have known were coming will have some explanations in behavioral economics.

Why are new theories of economics coming about?  Well, some of the principles that drive economists and our theories revolves around ideas like, “consumers make decisions at the margins.”  I'm sorry, but I am pretty sure no one goes to the grocery market and buys steaks one at a time.  Nor, do they buy a meal at a restaurant at the margin.  There is a reason why there is a saying that goes, “My eyes were bigger than my stomach.”

In the end, everyone is speculating.  Even in their everyday decisions, as shown above in the supermarket example.  I have really yet to hear anyone say this, but I would surmise that one of the more relevant differences between economics and finance is the difference between long and short term.

It's for the reason that the average person does not look so far into the future that behavioral economists exist.  With as many books that are now documenting our irrationality, one wonders if we were ever rational, looked into the future beyond five years, or how we even came up with principles for economics.

The principles of economics are not going anywhere, nor do I want them to.  However, the answers to economic problems are coming from different places these days.  A melding of academic disciplines is providing a new task force of economics.

The hope is that economists (or economics in general) start to get on the news more often.  Trust me on this.  Just turn on CNBC, and try to listen to anything of value.  You're not going to get anything.  You're going to hear “news items” that regard which stocks are moving up or down, or which are more being traded heavily.  You'll hear nothing on their balance sheets, their cash positions, their liquidity ratios, or anything of the sort.  At this point, we're not even talking about finance or economics, we're talking about day traders.

If I could wish for something else of value to come of this recent economic downturn, it's that we rethink how we present the economy, and news in general.  For example, GM's stock is down, does that mean they will stop making cars tomorrow?  No, so lets ask the questions above and ask about other questions in regard to what they are going to sell, or how their business model might change.

I understand news today scares everyone, but it doesn't mean we have to leave everyone uneducated.  And it does not mean that we have to keep looking at problems the same way. Present the economic news rationally, and we might start to respond rationally.


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