Why mind matters

I've always been one who's believed in 'consumer sentiment' and how that has an impact on consumption patterns, which then have macro repercussions.

Note an earlier post, 'I fear the biggest fallout of this recession would be on consumer sentiment. People, cutting back on purchases, on speculating on a depressed economic future. That would be dangerous as it would then 'down' disposable incomes, down consumption and that cycle surely will lead to a catastrophe.

So instead of looking at the recession as a correcting mechanism, at least in India, it should be feared as a phenomenon that can depress consumer markets with repercussions that will send the economy into an even worse spiral!

Niranjan Rajadhyaksha, writing in HT Mint reinforces the importance of understanding the workings of consumer minds and its implications. He writes;

'Another recent provocative piece on a similar issue is by Paul De Grauwe of the University of Leuven in Belgium. He argues that economists could not anticipate the financial crisis because they made extraordinary assumptions in their macroeconomic models about the cognitive abilities of human beings. Modern psychologists and behavioural economists have shown that humans can understand bits and pieces of the world, and hence depend on simple rules or heuristics to make choices. Correlations in such beliefs tend to create waves of optimism and pessimism that we see above all in the financial markets.

But standard economic models assume that humans are perfect calculating machines. De Grauwe calls for a bottom-up macroeconomics. “The bottom-up model has agents who experience an informational problem. They do not fully understand the nature of the shock or its transmission. They use a trial-and-error learning process aimed at distilling information. This process leads to waves of optimism and pessimism, which in a self-fulfilling way create business cycle movements. Booms and busts reflect the difficulties of economic agents trying to understand economic reality,” he says. In this way of looking at the world, economic cycles are caused by endogenous factors rooted in human cognitive limitations.'

Read Niranjan's complete article here.


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