Barry Ritholtz has one of his best blog posts ever. Mr. Ritholtz makes some interesting points that seem partially self-contradictory. Nevertheless, the points are all true. How can this be? Let me offer three explanations:
- Things change over time. Ritholtz says that sometimes “people behave the way they do because they have figured out a problem and are responding to it intelligently”. But the “figuring out” is not instantaneous – it takes time. Time also allows us to become accustomed to new conditions. As Ritholtz says, “the US consumer is no longer frozen like deer in headlights.”
- Things change at the margin. Everyone doesn’t figure out a problem at the same time nor become accustomed to some “new normal” at the same time. This is why stock markets resemble the action of “10 million panicked monkeys”. Since there are always new problems and new conditions, there are always some who reach correct conclusions before others.
- Change has a cost. Transaction costs can be high – there’s a lot of friction in the world. We teach introductory physics using a “frictionless world”. We teach economics the same way. Those frictionless models are not robust enough for the real world. Bridges collapse and markets go haywire. We understand friction in physics better than we do in economics.
Being mindful of these three things will change how you view a lot of things.