The field of psychology is usually ignored by mainstream economists, which, in its typically arrogant and closed practice, adopts a series of a priori assumptions about human behaviour – the so-called Homo economicus – where were are always rational and self-interested and, as a result, always make choices that maximise our present and future well-being based on available market signals. Real world forces that condition actual human behaviour, such as cognitive biases and irrationality, in general, as well as cooperative and collective behaviour is ignored by mainstream neo-classical (free market) economic theory, because admitting its dominance in human decision-making would void the entire edifice of that theory and scuttle the authority that is given to the on-going narratives about deregulation, small government, privatisation, pernicious cutting of income support, and the rest of the economic policies that have defined this dysfunctional neo-liberal era. But humans do not behave in the way economists suggest. We are a complex mass of irrationality, custom, habit, and affect. We certainly use cognitive processes in our decision making but often we take shortcuts based on affect. These tendencies are pushing our behaviour back to what was normal before the credit binge that led to the GFC. This shift in our behaviour is associated with stagnation and entrenched mass unemployment. But the reason for these parlous outcomes is not that we have returned to more normal spending behaviour but, rather, because governments have not realised that they had to return to more normal behaviour as well. Instead of promoting the benefits of austerity (in the face of all evidence to the contrary), governments should have been promoting the benefits of continuous fiscal deficits to support non-government saving desires and maintain better employment outcomes and stronger income growth.….The problem is not with the model based on homo economicus but with the scope of its application. The conventional interpretation of the model assumes the scope of the model is sufficiently congruent with actual affairs to approximate reality closely enough to be the foundation for policy analysis and formulation. However, outcomes reveal that the restrictive assumptions on which such models are based limit the scope so much that the model is not as representational as assumed and so the models fail as a policy tool.
There is also the issue of scale. The assumption is that the microfoundations of the model underlie macro behavior and can be used to project macro behavior. However, this involves the fallacy of composition, when it is assumed that what is true of a part of the whole is true of the whole. It also fails to take into account synergy, that is, the whole is greater than the sum of its part owing to relationships, interaction, feedback and reflexivity.
Modeling that restrictively assumes homo economicus, methodological individualism and a representative agent for tractablity fail owing to both scope and scale. Simple is a feature. Simplistic is a bug.
Some of the reasons for this failure of models based on homo economicus as policy tools are found in the psychological factors that Bill calls to attention. These psychological factors strongly influence individual preference and behavior and also underlie sociological effects that strongly influence group behavior.
Bill Mitchell – billy blog
Our affect is driving us back to a need for continuous fiscal deficits
Bill Mitchell | Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at University of Newcastle, NSW, Australia