BLOG: Economic behaviour – rational or emotional?

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Written by:
03/10/2012
Matt Smith muses on how our 'Animal Spirit' could be responsible for financial booms and busts
BLOG: Economic behaviour – rational or emotional?

Economics is a rational business, or so we mere mortals are led to believe, but the constant diet of volatile economic news weighs visibly upon many people I know.

Economics affects our mental wellbeing and consequently our behaviour. We see this expressed in some small measure as consumer confidence, but this does not do its impact justice.

Like many inconvenient truths, it’s our hard-wired instincts and behaviours rather than rational thought which determine our economics, and in a downward spiral these can create a feedback loop that doesn’t help anyone.

Economists have tended to underemphasize the importance of emotional factors, as the effects of emotions are difficult to model and quantify. It’s understandable as the keys to unlocking the mental nature of behaviour almost certainly sit within the medical profession.

But it’s not hard to see how our instincts rather than purely rational thinking and behaviour encourage economic phenomena such as booms and busts. When times are good we repeat successful behaviour because it feels right or good and we want more rewards. There is little risk or uncertainty in doing more.

When we are losing money we have to change because continuing as we were is unaffordable. As the saying goes, things always end badly, otherwise they wouldn’t end. Good news brings lower uncertainty because it promotes repetition.

This shouldn’t surprise us. We spend most of our lives building walls of certainty around ourselves and our loved ones because life is really a fragile business.

John Lennon wrote that, “Life is what happens while you are busy making other plans”. Our grip on our reality is swiftly undone by all manner of unpleasant natural, medical or just plain “bad luck” phenomena.

Our mental hard-wiring underpins economic behaviour.

Keynes knew this when he referred to our emotional capacity to inform our decisions as our Animal Spirit. In their book of the same name, Robert Shiller and his co-author, Nobel Laureate George Akerlof, continue this theme.

“We will never really understand important economic events unless we confront the fact that their causes are largely mental in nature.”

Our instincts for nesting, risk-taking, the emotional part of making good decisions, and greed manifest themselves in economic actions such as spending patterns or addictions, house purchases, investments, financial largesse to name a few. These things are hard-wired and are not the expression of purely rational thought.

The rational view of the world is seductive because it is convenient. It is an easily understood charter we can all sign up to in debate but if we really want to know more about why we behave the way we do. I suspect neuro-science might have more answers.

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