Robert Shiller on Behavioral Economics

I enjoyed this interview with Robert Shiller on behavioral economics.

I wanted to highlight three things. First, Shiller talks about the flaws in elegant and simple models when it comes to dealing with complexity. (This reminds me of some of the flaws aphorisms encourage.) Second, economists, like the rest of us, often miss the obvious. This happens for a variety of reasons but two of the bigger ones are: we don’t like information that contradicts what we know and we’re not that great at incorporating human misjudgment into our models. Finally, Shiller notes the reflexivity of complex adaptive systems.

Complicated

…It turns out that the human mind is very complicated. Economic theory likes to reduce human behaviour to a canonical form, the structure has been, ever since Samuelson wrote this a half century ago, that people want to maximise their consumption. All they want to do is consume goods; they don’t care about anyone else. There’s neither benevolence nor malevolence. All they care about is eating or getting goods and they want to smooth it, they described it in terms of so-called utility functions through their lifetime and that’s it. That is such an elegant simple model, but it’s too simple and if you look at what psychology shows, the mind is the product of human evolution and it has lots of different patterns of behaviour. The discoveries that psychologists make to economics are manifold.

Missing the Obvious

Economists just sometimes don’t see the obvious, they don’t rely on mental faculties of human judgment that they have as well as not relying on a broader view of people that’s informed by psychological or sociological research.

Reflexivity

One of the great concepts in economics came from the sociologist Robert K. Merton who in the 1940’s wrote an article called ‘Self-fulfilling Prophecy’; he coined that term in the 40s. And that’s exactly what the great depression was, a time when people became pessimistic about the economy and they stopped spending, so it made it happen. It also refers to a reason why economists are loathe to predict depressions, because they feel that it’s anti-social to set in mind a course in thinking. Especially central bankers feel reluctant to do that.