Economist lacking a sound understanding of how markets function tend to rely on psychological explanations for asset “bubbles” like those that preceded the current spate of economic & financial turmoil.
Most famously, John Maynard Keynes (General Theory of Employment, Interest & Money, 1936) alluded to “animal spirits” whereby people act impulsively & spontaneously without regard to rational calculations. More recently, Robert Shiller revived Keynes’ psycho-babble by making a cottage industry out of writing about “irrational exuberance” that can lead to financial ruin
In one sense, their point is banal in being a simple truism. Rash judgments can lead to unhappy ends. But serendipity might also lead to large gains.
What Keynes & Shiller & others worry about is that that “animal spirits” introduce a systematic tendency for markets to be unstable & prone to recession such that the negative impacts are widespread. Accepting this assertion invites the conclusion that government can & ought to intervene to restore sanity to markets.
It turns out that there are perfectly good economic explanations for recession that do not lead to conclusions that support an expansion in the role or actions of government.
In general, markets do NOT have an inherent tendency for wide swings in business cycles. This is because under normal conditions, “bulls” (optimists that believe value will rise) tend to be offset by “bears’ (pessimists that expect declining values).
Indeed, all (voluntary) market transactions require that people on opposite sides of the trade have differing views on the value of the object being exchanged. Otherwise, no trading would occur. Yet this seldom leads to financial collapse or economic distress.
Recessions or “busts” are almost always preceded by periods when most people are bullish & confident that values will continue rising.
If this happens in one sector of an economy as occurred during the real estate bubble in the US, values in other sectors must fall UNLESS more liquidity is pumped into the financial sector, an action primarily left to central banks.
As it turns out, bubbles & artificial “booms” throughout history can be traced to some form of monetary promiscuity. In modern times, central bankers artificially lower interest rates to reduce the cost of credit to households & businesses reduces the incentive to save & lowers the perceptions of risk.
Remember the fairy tale character of the Pied Piper of Hamelin that lured rats over the cliffs with alluring music? Consider central bankers as releasing paper money as a lure that induces otherwise sensible people to over-extend themselves before falling off a financial cliff.
Keynes’ & his followers fail to understand that the apparent “herding” behavior of home buyers & businesses becoming over-leveraged is driven by government policies that create distorted market signals.
It was once said that real men do not eat quiche. I am unconvinced that masculinity is challenged on the basis of food preferences. But I do believe that REAL economists must DO economics & that psycho-babble is for intellectual sissies that cannot grasp the elementary functioning of markets.