December 12, 2013
Economists like to think that they get to define the word “rationality.” They don’t. Economists tend to define a certain type of narrow behavior as “rational,” implying that anything else is “irrational.”
Binyamin Appelbaum falls into this trap at the end of an interesting piece on Stanley Fisher, when he refers to work by Janet Yellen and others which he says assumes that people are “predictably irrational.” Actually much of the behavior assumed in this work is entirely rational, even if it departs from the standard theory that economists would like to apply.
For example, it is not irrational for workers to resist a nominal wage cut from their employers, because this directly implies a reduction in relative wages, even if they would accept a cut in real wages due to inflation. This simply means that workers care about relative wages. Economists have no basis for calling this concern “irrational.” Economists are not supposed to be in the business of telling people what they should and should not value. If they care about their relative income, then this is fact that economists must accept, not condemn as irrational.
Much of Yellen’s work explores such departure’s from narrow rationality as defined by economic theory. However this points to an inadequacy of the definition of economic rationality, not the pervasiveness of irrational behavior.
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