Friday, 26 November 2010

Biases about economic facts

Those who defend rational expectations have some explaining to do, in the face of data like this:
...six in ten Americans think most of the money spent to rescue banks will be lost forever. Six in ten think the economy shrunk over the past year. One in two think federal income taxes have gone up in the past two years.
Wrong. Wrong. And wrong.
In theory, it would still be possible for rich, sophisticated arbitrageurs to bet against the public in all these areas, and thus bring the overall path of markets back in line with the predictions of any given model. But most of the wealth of the economy is (directly or indirectly) under the control of the people who have these wrong impressions; so I think it unlikely that rational expectations can effectively operate. Especially since the errors are not random, but systematic; Derek Thompson in the article above has five explanations for why this might be.

David Laibson gave a fascinating talk on this topic at the Geary Institute on Tuesday; he introduced the concept of natural expectations, which combine two different ways of predicting the future: first, an intuitive extrapolation of current trends; second, a rational expectations component which matches the real data. Laibson's forthcoming paper (with Andreas Fuster and Brock Mendel) explaining this model is here.

2 comments:

Min said...

As we all know, poll answers are very sensitive to wording. For instance, what does it mean to say that the bank bailout money is "lost"? (Not "lost forever". That wording would probably have altered the percentages.) Suppose that I am an ordinary citizen with only the vaguest notion of what TARP is, but I do know that we spent a helluva lot of money to save the Big Banks, and the next year they paid themselves a helluva lot of money in bonuses. As far as I am concerned, the bailout money was lost in the form of those bonuses. Is that an irrational interpretation?

And what does it mean to say that the economy shrank? That the GDP was less than last year? Now, the GDP is a measure of the national income. In a situation where most of the national income goes to a relatively small percentage of the population, what does the GDP have to do with TCMITS (The Common Man In The Street)? Is that what "the economy" means to him?

PunditusMaximus said...

In addition, "shrunk" almost certainly means "shrunk per-capita" in the popular mind.

Also, is anyone really claiming that the government is going to get even a dime on the dollar from Treasury's or the Fed's purchases of Mortgage-backed securities?

This article has a lot more to do with economists pretending than about people's biases.