ABSTRACT
In this chapter, we uncover the logic that underlies people’s evaluations of how macroeconomic variables interact. People typically think in terms of pairwise links, and not beyond. We present a study in which people were presented with pairs of variables (e.g., GNP, growth rate, wages, etc.) and asked to judge how a change in one would affect the other. Multidimensional scaling found that the variables neatly clustered into two groups: those perceived to be good (e.g., national credit rating, corporate profits), and those perceived to be bad (e.g., tax rate, inflation). Further, it was found that when people made pairwise judgments, they relied on a simple yet powerful trick: “good” things enhanced other “good” things and suppressed “bad” ones, while “bad” things enhanced other “bad” and suppressed “good” ones. This trick, dubbed the good-begets-good heuristic, explains how people manage to readily answer how any two variables interact, without a clue as to the mechanism responsible for the influence. The GBG heuristic means that on a large scale, people generate waves of optimism and pessimism, which go on to affect aggregate demand.
