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Commentary – Why the Financial Crisis Took Economists By Surprise

Never Saw It Coming – by Alan Greenspan:  “The economics of animal spirits, broadly speaking, covers a wide range of human actions and overlaps with much of the relatively new discipline of behavioral economics. The study aims to incorporate a more realistic version of behavior than the model of the wholly rational Homo economicus used for so long. Evidence indicates that this more realistic view of the way people behave in their day-by-day activities in the marketplace traces a path of economic growth that is somewhat lower than would be the case if people were truly rational economic actors. If people acted at the level of rationality presumed in standard economics textbooks, the world’s standard of living would be measurably higher. From the perspective of a forecaster, the issue is not whether behavior is rational but whether it is sufficiently repetitive and systematic to be numerically measured and predicted. The challenge is to better understand what Daniel Kahneman, a leading behavioral economist, refers to as “fast thinking”: the quick-reaction judgments on which people tend to base much, if not all, of their day-to-day decisions about financial markets. No one is immune to the emotions of fear and euphoria, which are among the predominant drivers of speculative markets. But people respond to fear and euphoria in different ways, and those responses create specific, observable patterns of thought and behavior.”

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