Bubbles and Behavioural Economics

Last month's Scientific American had an article entitled "The Science of Economic Bubbles and Busts". Broadly it paints a picture of the economics profession believing in efficient markets and the impossibility ofbubbles, at least until behavioural economics came along to explain to us how bubbles can exist. This ia hardly an accurate depiction. And it paints far too simplistic a picture of what caused the crisis. For example it suggests that basic irrationality was at its core: "A phenomenon like money illusion prevailed: the borrowers of these mortgages failed to calculate what would happen if interest rates rose." There may be an element of truth in this, but equally for many this was close to a one-way bet, borrowing 100% of the cost of a home and walking away when the property market collapsed. It certainly isn't obvious that this was ex ante irrational. And it suggests that a major new approach - better than standard economic modelling - is to use evolutionary simulation models to track rules of thumb trading in financial markets. Well, the truth is, this is nothing new. I can recall models of this type from 25 years ago, or more. It is hardly cutting edge.