Economics of Fear and Hysteria

I wrote an article here about the economics of fear. Basically, it looks at how economic decisions are often based on factors other than rational decision making. Quite often in economics we see behaviour known as ‘herding’. What this involves is people making decisions dependent on what other people are doing. Therefore, when economic confidence falls this can have far reaching implications as the negative attitudes affect many people.

There are a lot of economic decisions taken where people seek to avoid the worst outcome, basically this is the appeal of insurance. This shows how people tend to be risk averse, at least for large outcomes.

Related to risk aversion, is the idea of fear. It is often noted that consumers and producers can exaggerate a negative economic situation and feel it is worse than it actually is. An example of this is how many consumers can think the economy is in a recession, when it is actually growing by 2 – 3%. To a large extent, the media can be blamed for dramatising economic effects. For example, it makes a better headline to say:

“Housing Market Crash – biggest fall for 15 years.”

When actually they mean

“Monthly house prices decline, causing annual growth of house prices to fall to 6% “

Hysteria may sound a strong word, but, in some markets there can be an element of hysteria. This is when the market loses sight of reality and gets caught up in its own rhetoric. It is this market hysteria that has caused many bubbles. (booming prices distorted from reality, followed by a crash)

Often things in economics are not that bad, nor are they as good as some politicians would have us believe (remember the UK’s economic miracle of the late 80s ) – which mysteriously disappeared in 1991.