I have given some thought (about two minutes) to what is wrong with the economic theory that gave us the Great Moderation, with its eternal promise of no worldwide flood ever again, only the colors of rainbows. The temptation for theorists, in seeking a way forward, is to throw the baby out with the floodwater, and then the ark at the baby. But perhaps that would be a mistake. Perhaps the ark could be salvaged if a simple genetic modification were made to the baby. It has been customary to suppose that this baby is a rational human being, and moreover that this rational human being is representative of other human beings. Now, in all honesty, who here among us can claim to be represented by this?
This baby has always been a rational fool in the eyes of some, and lacking in judgment according to others. It was always going to be a tall order for it to carry on its shoulders all the responsibilities of a Great Moderation. Yet, theory suggested it was not only possible but certain, so now something has to give.
Here, out of a deep humanitarian concern for all, which in itself is a gross violation of the assumptions underpinning what has been considered respectable economic theory, I take a few moments out of my "schedule" to propose a simple but decisive break with tradition that will enable us to explain everything. Yes, at last, a theory of everything.
By "explain everything", do I mean that an end to the Great Moderation could have been anticipated before it happened? Yes. This would have been entirely predictable under our modified approach. Do I mean that crisis could have been anticipated? Yes. It would have been entirely predictable. Could we have foreseen popular demands for "contractionary expansionism" in the face of mass unemployment and underemployment. Yes! A thousand times yes. Entirely and utterly predictable!
The modification to the traditional rationality assumption that enables us to explain everything without requiring any other hand wringing or change in philosophy is simply this:
Many of us are morons.
That's it. One small but powerful change in mindset and we can explain it all.
Understand, it was generous of the economists to imagine that we were intelligent and logical – yes, even rational – human beings. But now is the time to be real. (Otherwise we would have to introduce money into the analysis, the love of which is the root of all evil. We don't want to go there.)
In economics classes, many of us learned the following seemingly innocuous axioms: that an individual's preferences are 1) complete, 2) transitive and 3) independent of irrelevant alternatives. For present purposes, which amount merely to the modest aim of putting on firm foundations our theory of everything, it will be unnecessary to look further.
Completeness. This says that all actions can be ranked in order of preference. Given two choices, A and B, either I prefer A to B, B to A, or am indifferent between A and B.
Transitivity. If A is preferred to B, and B is preferred to C, I must prefer A to C.
Independence of irrelevant alternatives. If I prefer A to B, introducing another alternative X will not make me prefer B to A.
Granted, at first glance these axioms seem innocuous. (When studying in the School of Economics, I memorized them by rote, without question, and recalled 2 out of 3 on exam day.) But are they really innocuous, taking into account our latest theoretical advance, namely, that many of us are morons?
To avoid offending anyone, I will take myself as a case in point. The justification for this is that I am an individual, and, without loss of generality, I maintain, an individual who is representative.
Now, if in fact I am interpreting the axioms correctly, (and who's to say in these postmodern days?), it turns out that none of them hold, at least in my case, the representative case.
Take completeness. According to this axiom, I either prefer A to B, B to A, or am indifferent. Oh how little I am understood!
Example. Action A is to read my friend's self-published book of verse. Action B is to attend a football game with a buddy.
To prefer A is to miss the football to read bad verse. To prefer B is to offend a good friend and budding poet. To be indifferent is to appear aloof, risking both friendships.
I neither prefer one action over the other nor remain indifferent. I am torn. Rife with anguish. A fiendish choice. God, why hath thou forsaken me?
Well, maybe my choices are at least transitive?
Let's see. I prefer blue to purple. I think blue's nice. I prefer purple to red. I don't know why. So, transitivity dictates I prefer blue to red. But how could I, when blue and red together evoke politics, with socialist red pitted against blue-blooded conservatism?
Perhaps if I was American I would satisfy transitivity in this case, thinking of blue states.
How about numbers?
I prefer 1 to 2 because 1 is smaller and odd. I prefer 2 to 3 because 2 is smaller and prime. So transitivity requires that I prefer 1 to 3. But I don't. 3, though larger, is odd and prime. That makes up for it. Why? Don't know, don't care, don't need to know, don't need to care. I'm a moron.
That leaves the independence of irrelevant alternatives, and this is where the current economic policy debate begins to make sense, if only we "escape from habitual modes of thought and expression".
In depressions I prefer A) fiscal expansion
to B) fiscal contraction.
But imagine X) a confidence fairy / a debt burden on our children / looming hyperinflation.
Now I prefer fiscal contraction.
Because cutting spending increases spending / reducing current production increases future production / Weimar Germany.
No, really, why?
I'm a moron.