Jeremy Clift profiles psychologist Daniel Kahneman
For Daniel Kahneman, one of the most moving episodes in the current global economic crisis took place when a humbled Alan Greenspan, the former chairman of the U.S. Federal Reserve, confessed before a congressional committee that he had put too much faith in the self-correcting power of free markets.
“He basically said that the framework within which we had been operating was false, and coming from Greenspan, that was impressive,” said Kahneman, who was awarded the Nobel Prize in Economics in 2002 for his pioneering work integrating aspects of psychological research into economic science.
But more to the point for Kahneman was how Greenspan, in his testimony, treated not only individuals but also financial institutions as rational agents. “That seemed to me to be ignoring not only psychology but also economics. He appeared to have a belief in the magic power of the market to discipline itself and yield good outcomes.”
Kahneman goes to great pains to stress that, as a psychologist, he is an outsider in the field of economics. But he helped lay the foundation for a new field of research, called behavioral economics, that challenged standard economic rational-choice theory to inject more realistic assumptions about human judgment and decision making.
Standard economic models assume that individuals will rationally try to maximize their benefits and minimize their costs. But, overturning some of the traditional tenets, behavioral economists show that people often make decisions based on guesses, emotion, intuition, and rules of thumb, rather than on cost-benefit analyses; that markets are plagued by herding behavior and groupthink; and that individual choices can frequently be affected by how prospective decisions are framed.
Fudenberg, Drew, 2006, “Advancing Beyond Advances in Behavioral Economics,” Journal of Economic Literature, Vol. XLIV (September), pp. 694–711.
Kahneman, Daniel, and Amos Tversky, 1979, Prospect Theory: An Analysis of Decision under Risk,” Econometrica, Vol. 47 (March), pp. 263–91.
Thaler, Richard H., and Cass R. Sunstein, 2008, Nudge: Improving Decisions About Health, Wealth, and Happiness (New Haven, Connecticut: Yale University Press).