Until this financial fiasco economists believed that the markets were efficient. The theory stated that all investors receive and act on all the market information as soon as it becomes available. And, it was assumed, all investors make rational decisions over the long term. That's now discredited.
Similarly, it was believed that consumers also make rational decisions in how they spend or withhold their money. That's also been discredited. In fact, according to recent studies even when we have a secure job with adequate income, we're handcuffed by psychological traps. Michael Rosenwald of the Washington Post writes in today's Post how this plays out in families.
If you're following my suggestion about how to read news commentary and looking for the key nugget, as usual, the information is half-way down the column. Here's the summary of the important issues:
Traditional economics assumes that we are all rational, that we approach these things very rationally, take in all the information, and then weight it and make a decision," said Thomas Gilovich, a Cornell psychologist and co-director of the university's Center for Behavioral Economics and Decision Research. "To a behavioral economist that seems clearly untrue."
Scary. But thankfully, there are some ways to avoid most of these traps. That's for still another post.