Just how wise are crowds? We might be about to find out the hard way.
Todays figures (table I of this pdf) show that net household borrowing - borrowing minus savings - hit a record high of £10.15bn in Q4.
Granted, this is partly payback for low borrowing earlier in the year. Even so, net borrowing in 2006 was 2.1% of GDP. Though less than in 2004, this is comparable to what we saw at the peak of Nigella's dad's boom in 1988.
There are two flatly contradictory ways of interpreting this.
1. It's a vote of confidence in the future. Consumers are borrowing because they anticipate higher incomes in future. This is one implication of the permanent income hypothesis and wisdom of crowds thesis.
2. It's a sign that consumers are feckless and irresponsible. When the bills come in, they'll have to curb spending, possibly causing recession and falling house prices.
The empirical evidence here is ambiguous. High borrowing in 1988-89 did indeed lead to falling spending and house prices, and the improvement in household finances in the early 90s led to stronger spending.
However, before 1988 and since the mid-90s, the link between net borrowing and subsequent moves in spending or house prices has been weak.
We're therefore thrown back onto our prejudices about the wisdom of crowds.
And a big issue here is: are individuals' irrationalities correlated or not?
The wisdom of crowds hypothesis assumes they are not, so for each spendthrift, there's a miser. Which raises the question: what sort of mechanisms can cause irrationally high spending to become correlated across people? How strong are they?
In this sense, macroeconomic forecasting is an issue in crowd psychology.
It's time you wrote more about cooking.
Posted by: dearieme | March 28, 2007 at 12:13 PM
Maybe attitudes become correlated because of widely-reported macroeconomic forecasting?
Posted by: Marcin Tustin | March 28, 2007 at 12:26 PM
More seriously, social pressures, and inaccurate mass media portrayals of lifestyles might well cause behaviours to become correlated.
Posted by: Marcin Tustin | March 28, 2007 at 12:27 PM
I wouldn't mind some social pressures with Nigella myself.
Posted by: bishop hill | March 28, 2007 at 12:43 PM
You're not suggesting that these assets will start deflating - are you?
Posted by: Rob Hayward | March 28, 2007 at 01:03 PM
Game theory. The assumption is that with a free market in housing (which we don't have but anyway) individuals will make rational choices based on self interest. At a societal level the result is a perfect market, responsive and flexible enough to meet all needs.
The psychology of home ownership is Social Comparison theory - keeping up with the Joneses
Posted by: Matt Munro | March 29, 2007 at 10:29 AM
Why the picture of that lovely cuddly lady off the telly?
Posted by: Mark Wadsworth | March 29, 2007 at 09:49 PM
'cos most of us would rather look at her than her dad?
Posted by: ian | April 04, 2007 at 09:39 PM