Behavioral economics covers the concept of “recency bias,” particularly as it applies to people’s investment decisions, where people see what has been happening most recently and assume it will continue. But are economists and policy makers also subject to recency bias?

EconExtra is a series of posts that go beyond the textbook, helping you incorporate current events into your classroom. This week: Behavioral Economics and Monetary Policy.

The Headline Issue

There are economists and journalists who have not been shy with their criticism of the Fed’s response or lack thereof when inflation first began to bubble up, or of government spending during the Pandemic. We had not seen inflation in decades, even as the labor market returned to pre-Financial Crisis levels a few years ago. Were policy makers too quick to dismiss the inflation as “transitive,” that is was simply the result of an unusual mix of increased demand and supply chain issues? Is this conclusion any different than the investment community in 2006-7 believing that housing prices would never go down?

Jon Hilsenrath, in his WSJ Saturday Essay entitled “Janet Yellen’s Learning Curve,” introduced the concept of recency bias early in the piece, and suggested that policy makers decisions through the pandemic may in fact have been influenced by recency bias. In the EconExtra on the Nobel Prize in Economics, the point was made that monetary policy makers modeled their pandemic reaction after Bernanke’s actions during the Financial Crisis, keeping credit cheap and flowing. And fiscal policy makers kept cash flowing to the population.

This article not only provides a retrospective on Janet Yellen’s career, if points out several instances across time where “recency bias” may have been responsible for less than optimal policy decisions around both the 2007-9 Financial Crisis and during the Pandemic.

The article quotes this reflection from Yellen:

“ The facts on the ground are constantly changing. History isn’t just repeating itself all of the time. You have to remain alert to really understanding the facts on the ground and what makes a particular episode different from what you have encountered in the past.”

Resources

• Investopedia definition and short discussion of recency bias
• WSJ Saturday Essay entitled “Janet Yellen’s Learning Curve”

Lesson Suggestion

Students can read the short Investopedia article describing “recency bias.” Then have them read the WSJ article on Janet Yellen.

Discussion Questions

1) Economic and financial theory assumes actors are rational and markets are efficient. How does recency bias interfere with both of these assumptions?

2) Give examples of situations where recency bias leads people to make poor (investing) decisions.

3) Give examples from the WSJ article of how economists may have been influenced by recency bias in their policy suggestions during the Financial Crisis (based on 2001 tech stock bust.) How did they miss the housing bubble?

4) Give examples from the WSJ article of how economists may have been influenced by recency bias in their policy suggestions during the Pandemic (based on the Financial Crisis.)

About the Author

Beth Tallman

Beth Tallman entered the working world armed with an MBA in finance and thoroughly enjoyed her first career working in manufacturing and telecommunications, including a stint overseas. She took advantage of an involuntary separation to try teaching high school math, something she had always dreamed of doing. When fate stepped in once again, Beth jumped on the opportunity to combine her passion for numbers, money, and education to develop curriculum and teach personal finance at Oberlin College. Beth now spends her time writing on personal finance and financial education, conducts student workshops, and develops finance curricula and educational content. She is also the Treasurer of Ohio Jump$tart Coalition for Personal Financial Literacy.