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Myth of the rational market

Conor Clarke observes that in Animal Spirits George A. Akerlof & Robert J. Shiller point to the popularity of Texas hold ’em as symptomatic of the speculative fever of the past decade. I’ve been reading a fair amount of financial history from the late 1990s and early 2000s. Skeptics of Shiller’s arguments during that period fairly depict his theses as a mishmash of post hoc ergo propter hoc. The problem is evident all through Irrational Exuberance, the book which made him the Cassandra of the age along with Nouriel Roubini. But though on the specific causal factors adduced I remain skeptical, in the generality I do think behavioral economic critics of constructs such as the efficient-market hypothesis are right. In The Myth of the Rational Voter Bryan Caplan lays out the case that democratic majoritarianism is often irrational in maximizing utility because not only are voters stupid in the aggregate, but their stupidity exhibits systematic biases. If their stupidity was randomly distributed then of course it would “cancel out” and the rational signal would be determinative of decision-making, but aggregate biases derived from the nature of human cognitive hardware can easily be the most powerful directive.
This is a world of irrationality, where reason is the slave of the passions. Those who argue for the power of the market due to its rationality, derived from the aggregate choices of individuals, need to confront this reality. That being said, those who argue for the rationality of economic planning through a centralized decision making structure have to confront the same realities (and also the track record of “natural experiments” in the command economy). I come not to bring peace of mind, but to bring a sword of uncertainty and avarice.

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