Alan Greenspan: predicting irrationality

My colleague Jerry sent over this clip from a CBS interview with Alan Greenspan, who was talking about his new book “The Map and the Territory” after spending two years looking back through economic data to try and figure out why huge crashes were so hard to predict.

One conclusion – they didn’t know how to model irrationality and other human variables that don’t fit neatly into classical economics and efficient market theory (which assume people are always rational).  “It became very apparent to me that we misunderstand how systematic fear is,” he said.  “The fear that led to panic selling and the euphoria that inflated the housing bubble were not factored into the Federal Reserve’s computer models.”

Greenspan used to believe irrational behavior could not be projected or analyzed.  Now, he says, “I was wrong.”

“You think you can put human behavior in a model or in an equation?” Mason asked.

“In fact, you can measure it,” Greenspan replied. “Because if you look at the business cycle, for example, euphoria drives it about, and then fear collapses it.  And you can take one example after the other, and they look alike.”

Even irrationality can have predictable patterns.