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Posts Tagged ‘economics’

Krugman on the meltdown

Posted by Andrew Cooper on February 7, 2009

I’ve been very unfair to economists here, once or twice suggesting the fact that very few of them appeared to notice the looming Global Economic Meltdown reflected badly on their profession.

This, however, is an economist who is worth listening to.  I’ve felt for some time that adversarial party politics simply can’t cope with the depth of our current economic crisis.  Krugman feels the same way, I think.  For example:

‘Somehow, Washington has lost any sense of what’s at stake — of the reality that we may well be falling into an economic abyss, and that if we do, it will be very hard to get out again.

It’s hard to exaggerate how much economic trouble we’re in. The crisis began with housing, but the implosion of the Bush-era housing bubble has set economic dominoes falling not just in the United States, but around the world.’

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Finger in the wind

Posted by Andrew Cooper on January 29, 2009

After hearing yesterday’s IMF forecast for the UK’s economy I wondered what they were saying this time last year.

According to this, they were suggesting that the economy would grow 2.4% in 2009.  By April they had revised this to 1.6% in both 08 and 09.  As late as July of 08 they’d revised the forecast for 09 to 1.7% and for 08 to 1.8%.

Their latest guess is that the UK economy will actually shrink by 2.8% this year.  What’s that line about past performance being no guide to future performance

I haven’t read the actual report so I don’t know whether the IMF’s economists are hedging their bets (‘the UK economy might shrink by 2.8% this year but, quite frankly, we haven’t got the faintest idea’).  Such is the level of gloom at present I guess that anything is possible.  One thing’s for sure, though: behaviour will determine what actually happens – the behaviour of politicians, investors and everyone else and how we will actually behave is impossible to predict with any certainty.

Talking of fingers in the wind, here’s how things looked in 2006 when US house prices had started falling but either probably would/or probably wouldn’t lead to a recession.   You can see how easily cognitive dissonance would ensure that readers only saw the ‘probably wouldn’t’.

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Daily Mash explains why Bank of England didn’t spot looming meltdown

Posted by Andrew Cooper on December 22, 2008

This seems entirely plausible to me.    Not so sure about the BBC’s version of the story, though.  The deputy governor of the bank says that they knew that borrowing was ‘crazy’ but they didn’t think it was ‘serious’.  

In what sense was he using the words ‘crazy’ and ‘serious’, do you think?  As I understand the situation (i.e. not very well, which means that I’m well qualified to run the BoE) a large part of the problem was that the accumlated debt was being converted into derivatives that no one really understood and which were being traded on the markets.  

This led to a vicious cycle: the investment bankers wanted more and debt to trade.  In the face of this insatiable demand,  the lenders handed out more and more money to people who would never be able to afford to repay it. Once the value of the underlying assets started to fall, the whole house of cards collapsed.   ‘Crazy’ certainly seems to be an appropriate adjective.  

As I pointed out in a previous post, psychologists have confirmed that everything – even things that didn’t actually happen – seem perfectly obvious given the benefit of hindsight.  Perhaps we should insist that the Bank of England’s board – and probably all other corporate boards – must include a fully qualified psychologist.

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There’s no such thing as a sure thing

Posted by Andrew Cooper on September 19, 2008

A banker

A banker

Of course there isn’t.  We all knew that.  Even the investment bankers who have triggered, as G W Bush put it, some ‘adjustments’ to the world’s financial systems, knew it.  Why, then, did they behave as if there was?

Yet again, it’s all psychology.  Economics plays no part whatsoever.  If they had behaved rationally, they wouldn’t have built an enormous bubble of pretend money using financial instruments that the vast majority of them (including, critically, those at the top of the firms which have failed) didn’t understand.

The situation obviously wasn’t helped by deregulation or rather, self regulation.  (‘Now children, here’s a big box of delicious sweets.  I am going now, but I want you to make sure that none of them are eaten although frankly I’m not that bothered.’)  But at the root of it is good old cogintive dissonance.  If you’re paying yourself a few million (or tens of millions, in some cases) a year you really want to believe that the machine that’s generating all that pretend money is reliable, fault free and will continue to do so, even though deep down you have an uncomfortable feeling that it can’t.  Cognitive dissonance simply says that if you want to believe something you will, despite any evidence that your belief makes no sense whatsoever. 

If you come across a fact or argument that is ‘dissonant’ with your belief, you rationalise it away so that you can hold on to your beliefs.  Beliefs are very much more important to us than facts – they are a vital part of the mental models we use to understand the world around us.  And as I’ve mentioned in posts on cognitive behaviour therapy, you feel how you think.  These guys really did think that they’d mastered the system and it made them feel good.  They certainly didn’t want to think that they were wrong.

But they were, and spectacularly so.  Astonishing, isn’t it, that no one spotted this coming?  Actually, no: It’s not astonishing at all.  Most of those who might have spotted it, and done something about it – notably our governments, which deregulated financial markets in the first place – were subject to cognitive dissonance as well, of course.   They couldn’t afford to admit that they’d allowed far too much deregulation.  And they really did convince themselves that the children would behave, even when faced with a very large box of delicious sweets.  

Virtually everything seems obvious with hindsight.  But we often don’t spot obvious things in advance. There are good reasons for cognitive dissoance being part of our highly evolved mental software: we need well developed mental models to make sense of the world around us.  But these internal models can have dangerous side effects.   As Mark Twain said, we can easily end up ‘believing things that just ain’t true’.

Here’s the BBC’s Robert Peston writing on his blog this morning:

“The breathtaking rises in the price of bank shares this morning are symptomatic of a stock market that is bereft of reason and is being driven almost purely by hysteria and momentum.”

Posted in economic meltdown, economists, psychology, thinking | Tagged: , , , , , , | 4 Comments »