A tweet thread on rational and irrational expectations

Rational expectations of something being risky, simply makes most stay away from it.

Irrational expectations of something being risky, though certainly not presenting a danger to our bank systems, might sadly means lost opportunities to grow the real economy.

Rational expectations of something being safe, does of course not hurt the economy nor the banking system.

Irrational expectations of something being safe can easily bring down our bank system, and our real economy with it.

But with their risk weighted capital bank requirements, much lower for what was perceived ex ante as safe, than for what was perceived as risky, the Basel Committee bank regulators, de facto, irrationally based it all on rational expectations.

http://subprimeregulations.blogspot.com/2018/08/risk-weighted-capital-requirements-for.html

PS. A tweet on tail risks

Economist Andrew Haldane. At least when acting as a bank regulator, you are admitting the wrong error you committed

Chief economist of Bank of England Andrew Haldane says “his profession must adapt to regain the trust of the public, claiming narrow models ignored ‘irrational behaviour’” “Chief economist of Bank of England admits errors in Brexit forecasting” The Guardian, January 5, 2017.

Hold it Mr Haldane! What you and other economists ignored. when acting as regulators, was that banks would, as always, behave perfectly rational, and lend to what they expected would yield them the highest risk adjusted returns on equity.

That is what you failed to understand when allowing banks to hold less capital against what was perceived, decreed or concocted as safe. That meant banks could leverage more, and so earn higher expected risk adjusted returns on equity, when lending to the “safe”. 

That distortion in the allocation of bank credit to the real economy, resulted in that banks end up lending too much at too low interest rates to the “safe”… which could be risky for the banks; and to little and too expensive to “risky” SMEs and entrepreneurs which is very dangerous for the economy.

Come on Mr. Haldane I dare you to answer the following verybasic questions.