Behavioural Economics ...and housing bubbles...and freedom

michaels

A look at the psychology behind Behavioural Economics:
http://www.bbc.co.uk/news/science-environment-26258662

Basically we often make 'intuitive' decisons rather than strictly rational ones and for evolutionary reasons such decisons are likely to be systematically biased.

What does this have to do with housing bubbles?

Classical economics says bubbles should not form as rationale economic agents will price things correctly, were a bubble to form it would be recognised as such and short selling etc would quickly deflate it - 'efficient markets' and all that. The Fed amongst others followed this doctorine and so concluded it had no mandate to manage 'suspected' asset bubbles.

However an asset bubble can inflate if just a few of the assumptions of rationality are relaxed - for example if all particiapnts assume they can 'time the market' and ride the upswing and also sell quickly enough to avoid the losees in the 'crash' - a typical intutive bias, after all are we not all above average drivers, lovers, etc?

What then worries me is that we are suddenly into 'market failure' territory where economics says that govt intervention can be beneficial. Problem is that once you decide that the govt can make better (more rationale) decisions than individuals you start banning smoking, unhealthy food, stressful activities, risky sports, risky sexual behaviour etc etc. Where is that line where we allow individuals to make their own decisions even if society as a whole decides it is not in the individuals best interest to behave in the way they choose to?

Generali

michaels wrote: »

A look at the psychology behind Behavioural Economics:
http://www.bbc.co.uk/news/science-environment-26258662

Basically we often make 'intuitive' decisons rather than strictly rational ones and for evolutionary reasons such decisons are likely to be systematically biased.

What does this have to do with housing bubbles?

Classical economics says bubbles should not form as rationale economic agents will price things correctly, were a bubble to form it would be recognised as such and short selling etc would quickly deflate it - 'efficient markets' and all that. The Fed amongst others followed this doctorine and so concluded it had no mandate to manage 'suspected' asset bubbles.

However an asset bubble can inflate if just a few of the assumptions of rationality are relaxed - for example if all particiapnts assume they can 'time the market' and ride the upswing and also sell quickly enough to avoid the losees in the 'crash' - a typical intutive bias, after all are we not all above average drivers, lovers, etc?

What then worries me is that we are suddenly into 'market failure' territory where economics says that govt intervention can be beneficial. Problem is that once you decide that the govt can make better (more rationale) decisions than individuals you start banning smoking, unhealthy food, stressful activities, risky sports, risky sexual behaviour etc etc. Where is that line where we allow individuals to make their own decisions even if society as a whole decides it is not in the individuals best interest to behave in the way they choose to?

It's very hard to see what Governments can reasonably do to prevent bubbles. Let's say house prices start to rise at 30% a year (IIRC that was the peak increase, albeit briefly, during the last rise/bubble in prices). IMHO, a bubble is caused by people not wishing to 'miss the boat', to 'get in while they can still afford it' and so on.

If the Government can bring in 'macroprudential' measures then in many ways that makes the panic worse. When MIRAS was abandoned yet announced in advance, prices were bid up by about 30% in 18 months to gain a small tax refund. Over here, the First Home Owners Grant was increased for a small time to $15,000 from $7,500. In some areas of Sydney prices were bid up by an estimated $100,000. (One for the empiricists this).

Even if changes aren't pre-announced but are considered a possibility then you can be sure the Saturday finance supplements in the newspapers will be all about 'speculation that the BoE is set to announce that your kids will never be able to afford a house ever'.

Generally, my advice for Government can be summed up as, don't just do something, stand there.

purch

I was always a big fan of "Fatty" Lawson, but that decision to announce the abolishing of the dual relief on MIRAS in the budget of 88, to be brought into force the following April was a monumental gaffe :eek:

Generali

purch wrote: »

I was always a big fan of "Fatty" Lawson, but that decision to announce the abolishing of the dual relief on MIRAS in the budget of 88, to be brought into force the following April was a monumental gaffe :eek:

Yup no problem with getting rid of MIRAS. Big problem with getting rid of MIRAS in a year or so. It was self-evidently stupid.

purch

In a strange coincidence, during the 1988 Budget speech a certain Rt Hon Alex Salmond was suspended from the house for shouting "This Budget is an obscenity" just after "Fatty" reduced Income Tax and Corporation Tax to 25%

Generali

purch wrote: »

In a strange coincidence, during the 1988 Budget speech a certain Rt Hon Alex Salmond was suspended from the house for shouting "This Budget is an obscenity" just after "Fatty" reduced Income Tax and Corporation Tax to 25%

That's a new one on me.

The vote to kick Salmond out of the chamber was passed 354 - 19. Those who voted for Mr S:

Abbott, Ms Diane, Canevan, Dennis, Clay, Bob, Corbyn, Jeremy, Cryer, Bob; Ewing, Mrs Margaret (Moray); Grant, Bernie (Tottenham); Heffer, Eric S.; Jones, leuan (Ynys M&oacu;n); Lamble, David; McGrady, Eddie; Madden, Max; Mahon, Mrs Alice; Nellist, Dave; Primarolo, Dawn; Salmond, Alex; Sedgemore, Brian; Skinner, Dennis; Thomas, Dr Dafydd Ells

There are some right dodgy fellow travelers there. Bernie Grant, supporter of cop killers anyone? Dianne 'White people love playing divide and rule. We shouldn't play their game' Abbott. 'Red' Dawn Primarolo. And many, many more...

The rest read like a list of the hard left parachuted into safe seats by Militant Tendency.

purch

The "Good Old Days"

I guess the Yes campaigners should be on the lookout for Income and Small Company Corporation tax rates to be increasing in Scotland to non-Obscene levels if they get their way :eek:

tomterm8

Okay, I agree with part of the article. People ARE irrational, and they make inefficient decisions all the time. (Also known as: The market is inefficient).

However, the conclusion that the article makes ignores the fact that People ARE irrational, and they make inefficient decisions all the time.

And governments are run by people.

So, they get decisions wrong most of the time, with the best will in the world, even when they aren't corrupt and dishonest.

michaels

tomterm8 wrote: »

Okay, I agree with part of the article. People ARE irrational, and they make inefficient decisions all the time. (Also known as: The market is inefficient).

However, the conclusion that the article makes ignores the fact that People ARE irrational, and they make inefficient decisions all the time.

And governments are run by people.

So, they get decisions wrong most of the time, with the best will in the world, even when they aren't corrupt and dishonest.

I think you'll find this is the BBC where there isn't a problem that can't be solved with more government.....

Conrad

michaels, did you catch Horizon last night? All about cognitive bias and how this by far dictates our thinking. Even 10 CIA expert intelligence analyst failed the test on the show and all succumbed to cognitive bias.

Generali

Conrad wrote: »

michaels, did you catch Horizon last night? All about cognitive bias and how this by far dictates our thinking. Even 10 CIA expert intelligence analyst failed the test on the show and all succumbed to cognitive bias.

At work we employ a behavioural economist and I went to see him talk a couple of weeks ago. It's a fascinating area.

He gave some brilliant examples. For instance, if you are a waiter and give a mint with the bill then tips rise by about 4% in the study he quoted.

So you leave 2 mints per diner and what happens? Tips rise by 15%.

However, what if you give the diner the bill with a mint, go to walk off then turn and say, "I just wanted to thank you for being such nice customers" and add a second mint? Tips go up by 35%. (Numbers might be wrong but they're ballpark correct).

I saw this in action, that if you give someone a thing and then they feel obliged at 2 stalls at the Royal Easter Show, a kind of country show on steroids. When I first came to Aus I was down on my uppers so I took a job canvassing at the Royal Easter Show.

Next to me was a couple of guys selling 'Super Chamois', you see them advertised on TV infomercials. They insisted that absolutely everyone who watched them took a sample, even people who came late. They'd stop the pitch in order to give a sample. These were microfiber cloths, cost maybe 20c each. They were selling 2 for $10. Every pitch they'd sell about 2-3 of them. They're making probably $250-300/hr for 10 hours for about 10 days. $25, 000 cleared for 10 days work. Do 4 shows a year and that's a solid middle class income.

The other was a bloke who wasn't selling nougat. He was there "to do a bit of marketing". He'd hand out trays of the stuff for free. He didn't care how much you ate. Of course if you wanted to buy some then he'd happily oblige. He was probably turning over similar money to the chamois guys, albeit from a higher cost base.