Sunday, 24 November 2013

Greenspan Still Doesn’t Get It

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Until recently, Alan Greenspan’s main argument to exonerate himself of responsibility for the 2007-2009 financial crisis has consisted in the claim that strong Asian demand for US treasury bonds kept interest rates on mortgages unusually low. Though he has not given up on this defense,  he is now emphasizing a different tack, as manifest in an article published in the current issue of Foreign Affairs. The article captures key themes elaborated in his latest book on the problem of forecasting, The Map and the Territory. His new tack is no better than the old tack.

Reprising what has lately become a very common refrain in financial commentary, Greenspan points the finger at the emotional side of human nature. This is the side where behavioral economics has recently made a name for itself in formulating its accounts of investor behaviour. Actually, this approach has a much older provenance, most famously conveyed in Keynes’ invocation of “animal spirits” in the General Theory of Employment, Interest, and Money.  On the Keynesian view that behavioral economics adopts, investors do not buy and sell securities by rationally processing all available information and calculating expected returns. Rather, their decision making is distorted by cognitive biases and swayed by the oscillating passions of fear and hope.

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