To What Extent Does a Rational Economic Man Exist?

By Timur Almazov

The agent of economic theory is rational, selfish, and his tastes do not change. Bruno Frey One of the biggest assumptions in standard economics is the idea of a rational economic man !t has been "idely used since the late #$ th %entury in the fields of political economics& both macro and microeconomics& and finance Economists are di'ided as to "hether the economic agent assumption can be used in economic theories While researching this topic& it became clear that most if not all of the economists (ne" the difference bet"een the economic agent and a real human& but did not necessarily understand the significance of those differences The )**+ financial crisis "as a turning point !t bac(fired on those "ho belie'ed that the economies could be controlled by mathematical e,uations and sho"ed that -psychology and irrational beha'ior play a much larger role in the economy.s functioning than rational economists had been "illing to admit/# The idea of -irrational beha'ior/ counter argues the rational economic man model and suggests that such an assumption should not be used The purpose of this essay is to focus characteristic of humans& "hich ma(es them core ! "ill explain the effects emotions ha'e and ho" through macroeconomic policies "e create a more stable economy on the most significant irrational 0 the emotional on global economic scale can control emotions and

Rationality
The standard economic model 12EM3 4 the one you "ill find in economic textboo(s& states that agents of an economy are rational What does rationality mean? The term does not ha'e a consistent definition Most social scientists argue that rational decisions are the ones that are not affected by emotional factors or cogniti'e instincts %ertain economists ha'e their o"n definition of rationality5 6ud"ig 'on Mises 1#$7$3 argued that any action is rational& stating that in any circumstance agents "ill choose an option that is most preferable to them therefore the most rational one for them
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Dan 8riely& Predictably Irrational: The 19arper%ollins& )**+3

idden !orces That "ha#e $ur %ecisions,

8lthough this definition of rationality is logical& it does not allo" us to see the important factors in'ol'ed in terms of determination of re'ealed preference Do "e base our preferences based on our health& economic profit& social standing or all of them? Because there is no single preference& "hich influences e'ery decision "e ma(e& 'on Mises.s model is not 'ery useful for economic theories Most economists agree that rational agents are those "ho ha'e the same constant preferences 1usually to ma(e a profit3 and ma(e -internally consistent/# decisions This means that rational people follo" logical coherence& "hich does not necessarily ha'e to be reasonable 8 rational person can belie'e in magic as long as all of his or hers other beliefs are consistent "ith the existence of magic 8lthough this definition is a poor description of humans 1"hich "ill be explained later3 it "as "idely used by economists such as Francis Edge"orth& :ilfredo ;areto and 6ionel Robbins as an assumption for their theories 6ater in #$<*s& the %hicago school of economics too( the idea of rational man as the =ustification for their proposal of mar(et deregulation Their =ustification "as simple5 if our decisions al"ays follo" logical coherence then "e should al"ays ma(e accurate =udgments& "hich benefit us most Thus there should be 4 -no interference "ith the indi'idual.s right to choose& unless the choices harm others /) This "as called the libertarian approach and it supported the idea that the mar(ets are efficient and should be left alone !f each indi'idual ma(es economically preferable decisions then there is no need for inter'ention& because neither the go'ernment nor any other outsider (no"s "hat is better for the people or the firms Therefore if there are any attempts to restrict the freedom of mar(ets& then the mar(et "ill only produce inferior results due to an inefficient spread of resources 8s the countries across the "orld "ere persuaded by this argument& a "a'e of deregulation> 1the reduction of go'ernment po"er in a particular industry3 allo"ed bigger freedom to different sectors especially the finance sector !n #$$$ the ?ramm06each0Billey 8ct& in 8merica& too( do"n barriers bet"een traditional ban(s& in'estment ban(s& and insurance companies& allo"ing the in'estment ban(ers to use the sa'ings deposits from commercial ban(s and in'est them into different securities 2oon after the @2 got rid of all of the ban(ing barriers& it tried to
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Aic( Wil(inson& An Introduction to Behavioral &conomics, 1;algra'e MacMillan& )**+3& p < ) Bohn Cay& The 'a# is not The Territory: An &ssay on The "tate of &conomics, Dhttp5EEineteconomics orgEblogEinetE=ohn0(ay0map0not0territory0essay0state0 economics& accessed )+ 8ug )*#>F > ?reg ;alast GThe %onfidential Memo at the 9eart of the ?lobal Financial %risis.& Dhttp5EE""" 'ice comEenHu(EreadElarry0summers0and0the0secret0end0game0memo& accessed )+ 8ug )*#>F

persuade other #IJ nations of WTO 1World Trade OrganiKation3 to do the same 8ll of the nations& apart from BraKil& agreed and as the barriers across the "orld "ere ta(en do"n& large ban(s "ere able to trade in ne" financial products& such as futures contracts and credit default s"aps For + years the mar(ets thri'ed across the "orld and go'ernment authorities belie'ed that there "as no need to regulate the financial sector The )**< financial crisis sho"ed that people cannot be left ungo'erned in the mar(et systems "e ha'e today 8lmost all of the #I7 nations that agreed to ta(e do"n the financial barriers in )*** fell into a recession + years later Only in 8merica& the financial crisis cost the economy more than L)) trillion # BraKil on the other hand& "hich did not deregulate its ban(ing system& managed to achie'e a < IM increase in ?D; in )**$ 9o" did the assumption that people "ere rational cause the financial crisis? Well& the in'estors didn.t (no" exactly "hat they "ere doing Most of their failed trades and decisions "ere based on the belief that the house prices "ill ne'er fall Therefore financial deri'ati'es that "ere made out of mortgages "ere traded bet"een the financial institutions "ith little concern about the ris( of the deri'ati'es !f someone "ouldn.t be able to pay the mortgage& then the ban( "ould ta(e his or her house as a collateral& thus still not ma(ing a loss By )**+ the mar(et for such deri'ati'es "as 'alued at LI$J trillion) 9o"e'er& "hen the housing mar(et did collapse& so did the 'alue of all the deri'ati'es& "hich could not be repaid by the mortgage borro"ers 2uddenly ban(s. assets became "orth less than their liabilities 4 the ban(s "ere ban(rupt 4 and the go'ernment had to bail them out so that the entire system "ouldn.t fail Whether the ban(ers. inability to comprehend the ris(& "hich they "ere dealing "ith& "as irrational is a topic of discussion 2ome economists argue that the in'estors "ere not irrational but rather sub=ect to bounded rationality !t implies that they could not ma(e rational decisions due to lac( of information& cogniti'e limitations or time constraint !f that is the case then the in'estors "ere still ma(ing the most logical decisions that their physical and mental capacity allo"ed them to do but their capacity "as not enough to pre'ent the mar(et crash @nfortunately in'estors "eren.t e'en boundedly rational 2ince the financial crisis "as de'eloping o'er years& time constraint "as not the
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MelendeK& EleaKar Da'id& GFinancial %risis %ost Tops L)) trillion& ?8O 2ays.& Dhttp5EE""" huffingtonpost comE)*#>E*)E#7Efinancial0crisis0cost0 gaoHnH)J+<II> html& accessed 7 2ep )*#>F
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Ban( of !nternal 2ettlements& G8mounts outstanding of o'er0the0counter 1OT%3 deri'ati'es.& D8mounts outstanding of o'er0the0counter 1OT%3 deri'ati'esF

issue The information about the upcoming crisis "as e'ident and some in'estors e'en too( ad'antage of it !n his boo( The Big "hort& Michael 6e"is described the causes of the credit crunch and the stories of in'estors "ho made profit on the collapse of deri'ati'es mar(et by -shorting/ on them 1betting that the deri'ati'es& mainly %DOs& "ill lose 'alue3 Economist Robert 2hiller "rote an article called -Bubble Trouble/# in "hich he predicted an imminent collapse in the @ 2 housing mar(et& and subse,uent financial panic a year prior to the actual mar(et collapse The sheer fact that some economists and in'estors managed to foresee the crisis means that there "as enough information suggesting the failure of the mar(et and that people had the mental capacity to understand "hat "as happening Therefore& since there "as no time constraint& no cogniti'e limitations and enough e'idence pointing to"ards the imminent crisis& people "ere not boundedly rationalN they "ere irrational

Why are "e irrational?

8s ! said before& ! "ill only focus on a single human beha'ior& "hich ma(es us economically irrational !t is important ho"e'er to note that there are many different "ays in "hich the unpredictable human beha'ior can oppose the economic agent model !n spite of this it "ould ta(e a boo( to describe each one of them

Emotions
Emotions are psychological expressions that help us to communicate "ith each other They are responsible for the creation of a -2ocial %ontract& a system of ethics that protects the species / ) For example& the emotion of guilt helps us to realiKe our mista(e and try to fix it& in the process influencing others to sometimes forgi'e us Emotions are 'ery important during social interactions because they help us bond "ith each other 9o"e'er they can be unhelpful in mar(et situations& because they can "orsen one.s decision0ma(ing s(ills 1"hich "ill be explained later3 8s "ell as emotional core& humans ha'e de'eloped a system of reason This system helps us ma(e logical decisions by e'aluating the options and choosing the most beneficial one 8lthough both emotional and reason systems are ac(no"ledged by philosophers& psychologists& and other social scientists& economists tend to lea'e the emotional system out of the picture Economists Robert 2hiller and ?eorge 8(erlof criticiKed this lac( of emotion consideration in the field of economics& in their boo( -8nimal 2pirits/ They argue that economists ha'e -de0emphasiKeDdF the
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Robert 2hiller GBubble Trouble.& Dhttp5EE""" pro=ect0 syndicate orgEcommentaryEbubble0trouble& accessed $ 2ep )*#>F ) !lana 2imons GWhy Do We 9a'e Emotions?.& Dhttp5EE""" psychologytoday comEblogEthe0literary0mindE)**$##E"hy0do0"e0 ha'e0emotions& accessed < 8ug )*#>F

importance of emotional factors& as the effects of emotions are difficult to model and ,uantify / !n their boo(& 2hiller and 8(erlof re=ect the -rational man/ model and try to find a -more realistic picture of human moti'ations and capacities/ The boo( only concentrates on emotions that affect people in mar(et situations such as fairness& confidence& corruption and argues that these emotions play a significant part in economics F8!RAE22 can cause people to ma(e decisions that aren.t in their best economic interests The most common experiment that sho"s this is the -@ltimatum game/ The game consists of t"o players& one being a proposer and the other being a responder The proposer is gi'en a certain amount of money and is as(ed to di'ide it bet"een him and the other player The responder has a choice of either accepting the money or refusing it& in "hich case neither the proposer nor the responder get anything To ma(e the game fair the t"o players are usually strangers Economic theory dictates that the most rational decision for the proposer "ould be to gi'e the responder the smallest amount of money& in order to maximiKing his or hers profits The responder should accept any sum of money as long as it is bigger than Kero because that "ould increase the responders. economic profit For example& if the initial sum of money is O#*& then the proposer should gi'e #p to the responder and (eep the rest 9o"e'er& the empirical data 1done by ?Pth& 2chmittberger& and 2ch"arKe in #$+)3 opposed the results that "ere predicted by the economic theory The responders re=ected on a'erage any offer that ga'e them less than >*M of the initial sum 8lso the proposers (ept on a'erage only J7M to themsel'es The results are be"ildering The responders "ere "illing to sacrifice their o"n profit in order to punish the other player "ho& in their opinion& proposed an -unfair/ offer 2uch beha'ior sho"ed that the social and mar(et "orlds do inter'ene From social point of 'ie"& the proposer should ha'e di'ided the sum I*5I* and his failure to do so de'eloped an emotion of unfairness in the responder 8lthough such human beha'ior is fa'orable& because it deters people from exploiting others& it allo"s unpredictable results 0 in terms of economic theory 0 to happen Thin( about it this "ay& firms that are treated unfairly& might spend their 'aluable resources on trying to damage or get e,ual "ith their competitors in result "asting their o"n capital as "ell as causing problems for other firms !nsider trading could also arise from unfair treatment of the employees "ho decide to punish their bosses by selling out the firms. secrets On the other hand& the data sho"ed that "e ha'e some aspects of rational agent When people are as(ed "hat they expect the outcome of the -@ltimatum game/ to be& most suggest a I*5I* di'ide& ho"e'er the sum "as on a'erage di'ided in ratio JI5>I thus sho"ing that self0

interest& not altruism& is the dominant feature of human beings The siKe of altruism that "e exhibit depends on the circumstances that "e are in Further experiments& in "hich t"o friends or t"o relati'es "ere tested& sho"ed that on a'erage the di'ision "as in the ratio I*5I* meaning that our self0interest is dependant on our en'ironment !f "e are surrounded by people "ho =udges our decisions and "hose =udgment "e care about& then "e tend to be less self0 interested !f& on the other hand& "e are in an en'ironment that doesn.t =udge us& then "e tend to sho" more selfish manner 2ome economists such as 6ord 8dair Turner # argue that in'estors ma(e self0interested decisions because "hen they "or( they are not =udged for fairness !n fact they might be e'en inspired to be unfair 8fter all& "ho on the Wall 2treet doesn.t (no" the phrase5 -?reed& for lac( of a better "ord& is good /) -8 better "ord/ is actually self(interest 2elf0interest is an important characteristic of an economic man !t implies that he ma(es the decisions that benefit him the most The "ay he does it is by calculating utility> of the options and choosing the most utiliKing one 9umans& ho"e'er& do not calculate utilities of different options e'ery time they ha'e to chooseN in fact it is hard for us to gi'e accurate calculations of benefits e'en if "e try !n his boo( -The ?eneral Theory of Employment& !nterest and Money/& Bohn Maynard Ceynes stated that a large proportion of human decisions depend -on spontaneous optimism rather than mathematical expectations/ Therefore "e choose "hat "e choose because "e feel confident about it& not necessarily because it is statistically more utiliKing for us 8ccording to 2hiller.s and 8(erlof.s boo(& confidence is the most important -animal spirit/ if one "ishes to understand the economy The authors argue that booms and busts are affected by general confidence le'el in the economy and that the economic definition of confidence is not correct The "ay the economists see confidence is as a dual e,uilibria5 humans ma(e either confident or unconfident predictions based on the information pro'ided 8 confident prediction suggests that the future "ill be prominent and unconfident prediction suggests that the future "ill be blea( 9umans then base their financial decisions 1such as expenditure& sa'ings3 according to their predictions 2ince the predictions are based on information pro'ided agents ma(e completely rational decisions 9o"e'er 2hiller and 8(erlof argue that confidence can sometimes be
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8n inter'ie" "ith 6ord 8dair Turner& G9as capitalism failed the "orld?. Dhttp5EE""" al=aKeera comEprogrammesEheadtoheadE)*#>E*JE)*#>J#)$7JI)+J#$ I+ htmlF ) Oli'er 2tone.s G)all "treet* Dhttp5EE""" imdb comEtitleEtt**$7)$#E?refHQsrH)F > @tility 4 ho" much benefit one could gain from an option

based on trust Trust that the economy is going to do "ell or that the house prices "on.t fall !t is not based on the information but on the emotions When "e trust something& "e tend to stop ,uestioning its legitimacy& "hich is a sign of irrational beha'ior 8s the authors put it5 -The 'ery meaning of trust is that "e go beyond the rational / There are many cases of people going -beyond the rational/ and putting too much faith in their decisions The results of such actions "ere the de'elopment of bubbles& "hich ended up causing a recession The ?reat Tulip Bubble# in #<th century sho"ed that o'erconfidence could result in the crash of e'en consumer mar(ets "here it is harder to inflate the 'alue of the product than it is in financial mar(ets Tulips "ere considered a luxury in #<th century 9olland 8t one point& the Tulip bulbs "ere o'erpriced so much that people "ere "illing to trade their entire sa'ings and e'en their property to get one !n #J>J a single Tulip could buy you a houseN by #J>< ho"e'er& the price of the Tulip "as the same as the price of a common onion The confidence rose because people thought that a tulip "as an extremely limited good& "hich "ould al"ays be demanded and "ould al"ays cost more than the price they paid Therefore people "ere ready to buy it at any cost confident that they can later sell it at higher price E'entually some traders decided to crystalliKe their profits because they didn.t thin( the price could go any higher Their sell0off triggered others to do the sameN li(e a domino effect %onfidence turned into a panic E'eryone started to sell but no one "as buyingN a big supply "ith a small demand meant that the price of the Tulip "ould fall dramatically The Tulip bubble collapsed in =ust four months and caused a nation"ide depression 8nother example& the Dotcom crash of )*** ) "as a result of in'estors. trust in "hat they percei'ed "as a -ne" economy/ There "as an enormous flo" of in'estments into 2ilicon :alley companies most of "hich ended up either ban(rupt or not profitable enough The in'estors got carried a"ay "ith great ideas of the !nternet 4 a ne" paradigm& and dismissed the actual business plans of the firms they "ere in'esting in The confidence in the -ne" mar(et/ "as so high that some of the !nternet and technology companies. !;Os 1first sale of pri'ate stoc( to the public3 doubled in price on the first day The in'estors "ere "illing to gi'e millions of dollars to the firms and expected them to become the next Microsoft !n reality most of the firms had poor business plans and "ere expecting small or e'en Kero profits
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8ndre" Beattie GMar(et %rashes5 The Tulip and Bulb %raKe.& Dhttp5EE""" in'estopedia comEfeaturesEcrashesEcrashes) asp& accessed #+ 8ug )*#>F
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8ndre" Beattie GMar(et %rashes5 The Dotcom %rash.& Dhttp5EE""" in'estopedia comEfeaturesEcrashesEcrashes+ asp& accessed #+ 8ug )*#>F

8s the time "ent by& the confidence started to fade "ith more and more information pointing out that most of the dotcom firms are not going to be profitable E'entually after companies burned up through their 'enture capital& they ceased trading and caused a panic among their in'estors By )**# the bubble "as ,uic(ly deflating and the A82D8R stoc( mar(et& "hich largely consisted of !T companies& lost <+M of its 'alue from March )*** to 2eptember )**) !f& on the other hand& people acted rationally and made logical decisions based on the information pro'ided5 examined the true "orth of a tulip bulb and the future profit expectations of the dotcom firms& then the mar(et crashes "ould ha'e been a'oided ?oing bac( to 9olly"ood& if the in'estors resembling 2poc( ran our economies& then the recessions or crashes "ould ne'er happen

Aormal emotional state

Economic bubbles burst "hen people ,uestion future prices When in'estors thin( they can no longer sell a certain asset at a higher price& they sell all of it& triggering others to do the same The number of sellers 1or suppliers3 in the mar(et increases 8t the same time the number of buyers 1or demanders3 falls Thus the mar(et ends in dise,uilibrium "ith too many sellers and too fe" buyers causing a rapid price drop Why does it happen? Why do people lose confidence? !n theory& if no one e'er accepts that the price of an asset is inflated then the bubble "ill ne'er burst Thin( about money Technically spea(ing it is a #**M li,uidity asset The only reason "hy money has 'alue is because of our mutual agreement that it does The price of an asset is only "hat the ma=ority belie'es it is& so "hy "ould the ma=ority realiKe that the price is inflated? !n #<I$ 8dam 2mith "rote a boo( called Theory of 'oral "entiments+& "hich argues that emotions& feeling and morality are essential parts of human beha'ior and should not be ignored by economists !n his boo( 2mith described a concept of normal emotional state5 -The mind of e'ery man& in a longer or shorter time& returns to its natural and usual state of tran,uility !n prosperity& after a certain time& it falls bac( to that stateN in ad'ersity& after a certain time it rises up to it / The idea of -natural state of tran,uility/ can explain "hy bubbles burst 8fter a -certain time/ of confidence people fall bac( to the -state of tran,uility/ When it happens& the in'estors start selling off the o'er'alued assets and spar( the collapse of the bubble 8s the assets lose their 'alue& people fall into a state of despair and e'en underprice the asset before returning to the normal emotional state and correct
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8dam 2mith& The Theory of 'oral "entiments, 1Sprinted for 8 Millar& in the 2trandN and 8 Cincaid and B Bell& in EdinburghS& #<I$3

asset price The diagram belo" sho"s human beha'ior pattern as the boom0bust cycle de'elops5

The grey0line represents the normal emotional state and period after ta(e0off sho"s ho" people become more and more confident 8t the point of -Ae" ;aradigm/ the bubble bursts and prices fall until the period of -Despair/ 8fter a short term of under'aluing an asset& people return to the mean& i e the normal emotional state ;sychology professor Timothy Wilson proposed a theory that explains "hy "e al"ays return to our normal emotional state 9e argues that o'er time& "e Gma(e sense. of e'ents and start to lose emotional po"er 8s time goes by certain e'ents that triggered some (ind of emotion become less surprising and trigger less emotional reaction Wilson described this process as ordiniKation meaning -ma(ing e'ents ordinary& predictable and explainable / Thus& if "e "ere rational& then our emotions "ouldn.t affect our decisions and the only state that "e "ould be in is the -state of tran,uility/

%an "e be (ept in our normal emotional state?

;re'iously ! ha'e tal(ed about the effects emotions ha'e on business cycle Essentially booms 1or bubbles3 appear due to o'erconfidence and crashes are caused by fear and panic 8lso& ! ha'e discussed our -state of tran,uility/ and ho" "e tend to ma(e more rational decisions "hile in this state !f "e& therefore& can control the confidence le'els in the economy then "e can also control business cycles 9o" to do that? Through macroeconomic policies

!nterest rates set up by the central ban(s in different countries& are essential in controlling the mar(et.s emotion le'els They directly affect the mar(et interest rates 1sa'ings and credit cards rates3 as "ell as the interests on asset prices 1mortgages& bonds& etc 3 !nterest rates regulate the amount of borro"ing that occurs in the economyN at the same time they can impact the confidence le'el !f the central ban( sets high interest rates& then the opportunity cost of borro"ing is higher& "hich leads to less borro"ing& a reduction in economic gro"th and a fall in confidence With higher interest rates less people "ould be able to borro" money and in'est it in an o'erpriced asset Thus the demand for the asset "ould be controlled and the deflation of the bubble "on.t be as damaging !f the interest rates are lo"& then the opportunity cost of borro"ing is also lo" Firms are more encouraged to ta(e loans and in'est thus increasing the general confidence le'el The effecti'eness of lo"ering interest rates is ho"e'er ,uestionable "hen countries are in a recession Thin( about ho" effecti'e the go'ernments. monetary policies ha'e been in Britain and 8merica The countries. interest rates are as lo" as * IM and to * )IM accordingly& but the policy has little effect in stimulating the economy Why does it not "or(? Well& Bapan spent < years finding the ans"er !n #$$*& land and stoc( prices in Bapan collapsed causing a recession The go'ernment tried to increase consumer and corporate spending by reducing the interest rates& "hich "ere already lo" before the collapse When the go'ernment dropped the interest rate to *M there "as still no increase in public expenditure 2ome economists belie'ed that Bapan fell into a -li,uidity trap/ 00 a situation in "hich the go'ernment could no longer use interest rates to stimulate the economy& because the interest rate is already Kero Ceynes argued that countries fall into li,uidity traps "hen people& ban(s and firms are so ris( a'erse that they prefer the li,uidity of cash to offering credit On the other hand& Richard Coo#& the %hief Economist in Aomura Research !nstitute argues that the companies "eren.t borro"ing during the recession& because they already had too much debt The firms. assets lost 'alue and could no longer co'er the firms. liabilities Therefore the firms "ere ban(rupt and had to pay off their debt before they could start borro"ing again This explains "hy in #$$I& "hen the interest rates "ere dropped to Kero& the net debt payment in Bapan "as o'er T>* trillion or JM of its ?D; !n other "ords the net payment of the firms. debts "as significantly bigger than their net borro"ing Because no one "as borro"ing& the recession became more and more damaging !n a country.s economy money that is sa'ed& should be spent some"here else& to (eep the economy going ;eople and firms "ere putting sa'ings into financial institutions& but no one "as spending that
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!nter'ie" "ith Richard Coo& Dhttp5EE""" youtube comE"atch?'Q9aAx8K6Ceg@F

money& "hich caused a decrease in money in the economy For example& a "or(er "ho had a T#*** income& "ould spend T$** and put the other #*M i e T#**& into sa'ings account Because those T#** "ere in a ban( and no one borro"ed them& it "as almost as if they "ere out of the economy !f the money is out of the economy& income falls 2o the "or(er.s income dropped from T#*** to T$** !f he again puts #*M into sa'ings account& that is another T$* out of the system lea'ing the "or(er "ith T+#* income !f this continues "ithout go'ernment inter'ention& the income as "ell as the money that is spent in the economy become smaller and smaller at the same time stimulating the recession !n fact the same e'ent occurred in @28 in #$)$ and =ust after four years of no go'ernmental inter'ention 8merican ?D; fell by I*M Bapan figured out that it "as in the same position as the @28 "as J* years ago& "hen the Wall 2treet collapsed& and decided& =ust li(e Roose'elt& to use fiscal stimulus to get out of the recession 2ince the go'ernment had no budget surplus& it had to borro" from somebody 9o"e'er& the Bapanese go'ernment decided not to ta(e loans from foreign countries& but instead from its o"n financial institutions That "ay& the go'ernment had more control o'er the process of repaying the debt !n effect the go'ernment too( the pri'ate sector.s role and borro"ed from the financial institutes 8s the fiscal stimulus "as in=ected into the economy& the ?D; began to gro" and "hen most of the firms cleared their balance sheets& they started to borro" again Thus the combination of fiscal stimulus and the interest rates can ha'e a direct impact on people.s economic decisions Macroeconomic policies can in effect be a "ay of ma(ing humans act more li(e rational economic agents !f "e are too economically irrational to be left alone& li(e "e "ere for the past 7* years& then "e should be -nudged/ to act more rational Richard Thaler& a professor of economics in %hicago @ni'ersity& "rote a boo( called -Audge/& "hich demonstrates ho" humans can impro'e their decisions if they are gi'en a slight incenti'e One of the examples in the boo( "as ho" an image of a fly on urinals in 8msterdam airport reduced the spillage by +*M !f such idea can be imitated in economic "orld& then "e can create a society "here people "ould be Gnudged. to ma(e rational economic decisions and to some extent replicate the rational economic man 9o"e'er& our possession of emotional core& our tendencies to lie& to ignore& to be o'erconfident& "ill al"ays (eep us a"ay from being the rational creatures that are described in economics textboo(s

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