Friday, June 28, 2019

A textbook on the supposed cause of the 2008 recession

While surveying the textbooks to see how much content they devote to behavioural economics, I was surprised by a claim in the new text by William Baumol, Allan Blinder and John Solow – Microeconomics: Principles and Policy (2020). Like most texts, this one has a brief discussion (pages 91-93) of behavioural economics. Its importance for microeconomic behaviour is dismissed, but they do claim that irrational behaviour in stock markets can have a large effect on the overall economy. The example they give is truly bizarre:

"… irrational behavior can have an enormous effect on the economy. Returning to our stock market example, when investors rush to sell their stocks simply because they see that others are selling, the result may be an abrupt and prolonged decline in stock market prices. This irrational selling behavior can trigger the process that drives the economy into recession. The Great Recession of 2007–2009 is only one of many historical examples of recessions that have been triggered by stock market investors who irrationally followed the behavior of other investors (i.e., herd behavior)." (P. 93, my emphasis).

Apparently the bursting of the housing bubble in the United States and the cascading effect that it had on financial institutions, culminating in the collapse of Lehman Brothers on September 15, 2008 was no cause for alarm. 

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