Economics of Happiness

August 7, 2012 — 4 Comments

“Textbooks describe economics as the study of the allocation of scarce resources.  That definition may indeed be the “what,” but it certainly is not the ‘why.'”

-Ben Bernanke

On Monday Ben Bernanke, Chairman of the Federal Reserve, gave a speech about economic measurements. This speech was unusual because he was not focusing on indicators such as GDP, inflation, and unemployment rates; the Chairman instead took a philosophical approach and questioned the relevancy of these traditional statistics to happiness.

Before I continue, it is important to note that the Federal reserve focuses on the aforementioned numbers because our Central Bank has a dual mandate – to keep inflation within a standard range while maximizing employment. (note that the European Central Bank does not have a dual mandate, and focuses exclusively on inflation).

Bernanke details a number of other economic indicators which might be able to guide the Federal Reserve towards making more informed economic decisions: How secure do Americans feel in their jobs? How confident are they in their future job prospects? How prepared are families for financial shocks?

This is an interesting and exciting development, and I firmly believe that our economy could use more detailed and thoughtful economic analysis. The amount of data available to Economists today is mind-boggling. Innovative Central Banks, such as Israel’s, have been utilizing Google Search Results to inform their decision making. According to a paper by Google Chief Economist, Hal Varian, adding Google Trends to traditional indicators leads to an 18% improvement in predictions for ‘Motor vehicles and Parts’ and a 12% improvement for ‘New Housing Starts’.

The Federal Reserve works in a deliberate fashion, but I’m excited for the potential of leveraging the vast amounts of data produced by internet users to improve economic decision making.

Sean

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  • Justin

    I’m really excited about this too. Now that Bernanke’s on the “happiness bandwagon,” how soon do you think we’ll see change in policy and in the way economics is taught?

    • Sean

      Thanks for the comment, glad to hear you’ve joined the bandwagon.

      I think we’ve already started to see a shift in the way finance and economics are taught. If you’re not already familiar with behavioral economics/finance I recommend you read up on the subjects; Dan Ariely and Hersh Shefrin are worth checking out.

      As for implementation, as far as I can tell its already happening. Just don’t expect the Fed to change overnight. And I don’t ever foresee Congress altering their Dual Mandate.

      • Justin

        I’m somewhat familiar with Dan Ariely, but I wasn’t aware of Hersh Shefrin. Thanks for the tip.

        Although, in terms of policy (and not necessarily regarding the Fed) and education, I don’t think behavioral economics goes far enough. The insights are valuable, but it doesn’t provoke a philosophical rethinking of the discipline, like Bernanke’s speech, or, say, Robert Skidelsky’s latest book “How Much Is Enough?”

        • Sean

          I agree with you there, but academia and bureaucracy are not known for innovation.

          The blending of psychology into traditional economic study will hopefully improve the accuracy of the field.

          Risk metrics, such as VAR and Drawdown, have failed financial firms. I hope this new discipline can provide more insight into the risks taken by financial institutions. I also recommend reading Benoit Mandelbrot’s work on fractal finance.