The rationality debate, simmering in Stockholm By Robert J. Shiller January 18, 2014 – The New York Times

Are people really rational in their economic about rare events, and overconfidence, all of decision making? That question divides the which I view as being more or less irrational. economics profession today, and the divisions My own talk seemed to put me at one extreme, were evident at the Nobel Week events in with Mr. Fama occupying the other. I said that Stockholm last month. aggregate stock price movements were mostly There were related questions, too: Does it make irrational, but I don’t believe I was as radical as sense to suppose that economic decisions or some might imagine, because I still advocated market prices can be modeled in the precise a free-market system, with innovations to make way that mathematical economists have it work better. traditionally favored? Or is there some I was the most willing of the three of us to emotionality in all of us that defies such incorporate ideas about nonrational or modeling? irrational behavior from other social sciences: This debate isn’t merely academic. It’s psychology, sociology, political science and fundamental, and the answers affect nearly anthropology. everyone. Are speculative market booms and I’ve been studying Nobel lectures of our busts — like those that led to the recent predecessors, and the debate doesn’t seem new. financial crisis — examples of rational human Judging from their words, many laureates — reactions to new information, or of crazy fads including Herbert Simon in 1978, Maurice and bubbles? Is it reasonable to base theories of Allais in 1988, Daniel Kahneman in 2002, economic behavior, which surely has a rational, Vernon Smith in 2002, Elinor Ostrom in 2009 calculating component, on the assumption that and Oliver Williamson in 2009 — have only that component matters? questioned whether economic actors are The three of us who shared the Nobel in rationally pursuing self-interest, as traditional economic science — Eugene F. Fama, Lars economic theory assumes. Peter Hansen and I — gave very different It is hard to sum up all this discussion, however, answers in our Nobel lectures. Mr. Fama’s because of a basic problem: defining “rational.” speech summarized his many years of research Christopher Sims, a Nobel laureate in 2011, has in strong support for the notion of economic proposed that inattention to the facts can be rationality. He marshaled evidence suggesting rational, if you define the word broadly. that share prices respond almost perfectly to Rational people know that their time is limited information about stock splits and that interest and realize that they cannot know everything. rates “contain rational forecasts of inflation.” They must choose what they pay attention to. Mr. Hansen seemed to occupy a centrist Mr. Sims’s argument suggests that it may be position in the debate. In his lecture, he spoke rational for busy people not to balance their of “distorted beliefs” that he said help account checkbooks if they feel they don’t have the for some otherwise incongruous empirical time, though they know they will make evidence about financial markets’ behavior. He mistakes as a result. emphasized mathematical models that contain elements of rationality but also take into But if people feel that the work of balancing a account features like animal spirits, beliefs checkbook is just too unpleasant, it’s less obvious how to classify their behavior. Some considered the admonition of the philosopher kinds of inattention are even harder to Descartes to keep emotions away from our categorize. What about people who decide they rational thinking. Mr. Damasio examined don’t have the time to read the news research finding that emotional pathways in the thoughtfully enough to consider whether they brain are interlinked with our calculating, will buy a house during a boom, and thus make ostensibly rational counterparts. decisions based on nothing more than hearsay The neuroeconomist Ernst Fehr at the and emotions? University of Zurich — who I hope will Such questions aren’t confined to economics. someday become a Nobel laureate himself — Political science has a similar conflict. People has used functional magnetic resonance often seem emotionally involved — even imaging, or fMRIs, to study people playing irrational — when talking politics. In their 1996 games involving economics and finance. His book, “Pathologies of Rational Choice summary of his and many colleagues’ research Theory,” Donald Green and Ian Shapiro, two shows unequivocally that there are links political scientists, describe their colleagues’ between rational and emotional decision- “highly charged debates about the merits of making. When a game player makes an rational choice theory.” apparently calculated, rational decision to take an aggressive action against his opponent, Other sciences are approaching such questions emotional and social pathways light up as well, in novel ways. Brain-imaging techniques are suggesting that the decision wasn’t entirely improving our understanding of the cognitive rational. neuroscience of attention, revealing the physical structures that allow us to process The question is not simply whether people are information as well as we do, and giving rational. It’s about how best to describe their material form to some of the abstract notions in complex behavior. A broader notion of Mr. Sims’s theory of rational inattention. This irrationality may someday be reconciled with research, identifying physical structures that one of rationality, and account for actual human underlie our thinking, has a welcome behavior. My bet is that real progress will come concreteness. from outside economics — from other social sciences, and even from information sciences Neuroscience is also showing important links and computer engineering. between people’s emotions and behavior they consider rational. In his 1994 book “Descartes’ Robert J. Shiller is Sterling Professor of Economics at Error,” the neuroscientist Antonio Damasio Yale.