Wednesday, March 18, 2009

Perception is reality

The role of expectations is very very important in economics. Expectations plays a key role in driving demand. Expectations are driven by perceptions and perceptions are driven largely by the announcements that you hear. Quite often these announcements are made by leading organizations, economists, or even political leaders.
In short- What these leaders or organizations say actually does play a key role in how the market moves.

Here is an experiment to explain this-
Consider a room with 100 people and assume that they stay there for the next few weeks.
Scenario A
Now, before letting them go tell them that the economy is in a bad shape and soon there will be a financial crisis. What would you expect from these people when they go out in the real world?
I expect them to be bearish about future and share they concern with other people, who in turn will pass on this bad/sad mood to others.
Scenario B
Before letting them go tell them that the economy is growing. Everyone is happy and bullish about future. Go enjoy life.
I would expect them to go out happy spread this happy feeling to others.
Points I am trying to make are the following:
1. If political leaders and economists show optimism/pessimism in their speeches/announcements then this will influence the rate of change (positive or negative)
2. The perceptions are taken to be reality by not some but many individuals. Not every individual will keep a check on how interest rates/inflation/GDP is moving. They will get influenced a lot by what they are hearing

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