One might agree, in theory, that people should base their economic decisions or judgments on rational expectations and forecasts. But a recent study of hindsight bias--the "I knew it all along" effect--in economic expectations found that people's need to be right is stronger than their ability to be objective.
The study's backdrop was the introduction of the euro as the official book currency of the European Monetary Union (EMU) states in 1999. Authors Erik Hölzl, PhD, Erich Kirchler, PhD, and Christa Rodler, PhD, of the University of Vienna, analyzed survey data from psychology and business administration students and employees who rated the probabilities of several economic developments six months before and one year after the introduction of the euro--which became the EMU currency this year. About 120 participants completed the first part of the survey in May 1998; 75 mailed back the follow-up questionnaire a year later.
Other surveys have shown that European integration and EMU were perceived positively by a majority of European citizens, but a significant percentage of people oppose integration, the authors report. "Arguments both for and against the single currency are related to economic expectations, political issues, social changes, etc.," they said. "Most arguments are highly emotional, and no certain outcome can be predicted."
For their study, the authors wanted to explore the notion that hindsight bias is moderated by attitudes toward the perceived cause of economic developments. The study's findings, which were consistent with the authors' hypotheses, included that:
Hindsight bias was greater for developments that did occur than for those that didn't.
Both euro supporters and opponents fell victim to hindsight bias selectively for favorable results or developments consistent with their own attitudes.
But why do people "fall prey" to hindsight bias--which affects subject experts and amateurs alike? Are they just know-it-alls by nature? It's not just that they need to appear more knowledgeable, conclude the authors. "If people like to come across as knowledgeable, they should also do so with regard to events that did not happen."
The authors suggest that a more plausible explanation is a "rejudgment process that is influenced by the participants' attitude toward the perceived cause of the economic developments."
The paper, "Hindsight bias in economic expectations: I knew all along what I want to hear," appears in the June issue of the Journal of Applied Psychology (Vol. 87, No. 2).