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Behavioural Economics and the 2008 Financial Crisis

28 July 2020

4 mins

Author: Tobie Timmermans

Hindsight – the unfair belief that I should have started collecting research for my dissertation earlier when in reality, I think it is important to not get bogged down in pages on notes but instead allow your dissertation subject time to develop gradually. But also, it perfectly summarises the link between my degree as a history student and my dissertation in behavioural economics and the 2008 financial crisis.

Across my time studying history, I was taught not to approach any aspect of the past at face value but instead to understand different biases in order to reach an accurate conclusion. Whilst both studying economics during my year abroad in the US and looking for jobs in my final year of university, I regularly found myself explaining the significance of a history degree. My reasoning is simple. You can often learn from history and use it to analyse, understand and explain the present and/or future. By applying the historical context of behavioural economics to the 2008 crisis, I believed I could illustrate this.

Hindsight bias makes it easy for economists, bankers and government advisors to insist that the crisis should have been foreseen before it caused global catastrophe. However, in reality very few people predicted it, and even fewer could understand it. One of those who did, was Robert Shiller who voiced his opinion that the housing bubble in America would burst and a worldwide recession would follow.

Shiller based his argument on behavioural economic theory – an inter-disciplinary study of psychology and economics – that had been developed across the previous two centuries but did not become academically apparent until the late 20th century and didn’t become mainstream until the causes of the financial crisis unfolded following 2008.

My dissertation, primarily aimed at using history to understand the present, used key behavioural economic research journals from the latter half of the 20th century to explain the causes of the crisis in the US and analyse the economic model’s proficiency in government policymaking going forward. I analysed the limitations of the widely accepted neoclassical models including the efficient market hypothesis which attempts to predict financial market movements based on the rationality of human beings.

Instead, using quantitative data such as graphs and tables, I demonstrated the effect behavioural theories like human irrationality, limited cognitive ability, short-term bias and overconfidence had on financial markets in the United States that caused the economic crash. Whilst behavioural economics is neither a new nor an under-researched sub-discipline, its real-life application is minor, and I attempted to fill this void. By combining the two topics and following the development of behavioural economics, I evaluated its application potential going forward which has thus far seen inadequate implementation in policymaking. However, with greater improvements based on historical research, behavioural economics and the understanding of real human nature may enable the prevention of future financial crises which, according to US Senator Elizabeth Warren, will reoccur every 15 to 20 years if human irrationality is uncapped. This study is one of extreme importance and one I will continue to research in the future.

Bio: My name is Tobie Timmermans, I have recently (2020) graduated from Loughborough University with a First-class Honours in BA History accompanied by an international Diploma of Studies following my year abroad in the United States majoring in International Business and Economics at Oklahoma State University. I plan to move back to the US to pursue a career in Business Analysis and Management Consulting which was largely inspired by my Dissertation subject; Behavioural Economics and the 2008 Financial Crisis in which I achieved a mark of 75.

Photo by David McBee from Pexels

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