Wednesday, July 1, 2009

B F Skinner, the Fed, and the housing market

Here is a psychologist’s perspective on the housing bubble: it may just be the result of positive reinforcement. Burrhus Frederic Skinner, a US psychologist was an early pioneer of the "reinforcement" construct in behavioral science.

Here is the definition of what's called Positive Reinforcement:
Positive reinforcement is an increase in the future frequency of a behavior due to the addition of a stimulus immediately following a response. Giving (or adding) food to a dog contingent on its sitting is an example of positive reinforcement (if this results in an increase in the future behavior of the dog sitting). Note that in order for positive reinforcement to be effective, the stimulus doesn't need to be intentional.

What does this have to do with housing? Well over the last 20 years or so the Fed has been providing stimulus to the housing markets and built up a nice positive reinforcement process.

Here is a chart showing the Fed Funds target rate and the Case-Shiller YOY housing price changes. One can point to 3 cases (particularly the last case) when slower growth in housing prices was quickly followed by an accommodative action by the Fed. Whether or not the Fed was actually trying to prop up the housing market is irrelevant - the reason for stimulus has nothing to do with developing a certain response behavior.

This is to a large extent what got banks, consumers, and rating agencies behaving in ways they did with respect to housing. Sadly some of the roots of this crisis may just come down to the basic concept of stimulus-response.

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