The EconomistDecember 14th 2019 Finance & economics 65B
arack obama’sintelligence officers
told him, variously, that there was a
probability of between 30% and 95% that
Osama bin Laden was in the Abbottabad
compound in Pakistan in April 2011. The
president was having none of it. “This is
50:50,” he said. “Look guys, this is a flip of
the coin.” That bin Laden was found and
killed does not reveal whose estimate of
the odds was best. But new research
argues that Mr Obama’s instinct—to treat
probabilities as evenly split when they
are uncertain—is widespread.
In a working paper Benjamin Enke
and Thomas Graeber, both of Harvard
University, argue that the bias towards
50:50 has shown up in many contexts.
One is decision-making under (known)
risks, such as gambling at a (fair) slot
machine. Economists have long realised
that people are more sensitive to changes
in probabilities, the nearer they are to the
boundaries of 0% and 100%. For ex-
ample, the chance of a big win of, say,
$1m rising from 0% to 1% seems much
more significant than the chance of the
same win rising from 20% to 21%. At the
extremes, there is a tendency to com-
press odds towards evens.
Mr Obama did not face known odds,
but ambiguous ones. Other researchers
have found that such uncertainty has a
similar compression effect: it can make
people act as if they are facing known
odds that are closer to 50:50 than might
seem rational, given the information on
offer. Messrs Enke and Graeber argue that
this tendency even shows up in surveys
of expectations about the performance of
the economy and the stockmarket.
The authors suggest a new theory to
explain this behaviour: “cognitive uncer-
tainty”. It could be described as a simple
lack of confidence. If people know thatthey may not be doing the sums right, or
that their memory may be failing them,
or that they are not sure what their own
preferences are, then their choices de-
pend less on the information they are
presented and more on a “mental de-
fault” of equal probabilities.
In a series of online gambling experi-
ments Mr Enke and Mr Graeber show that
the more uncertain people are in their
judgments, the more likely they are to
hedge their bets—even when they have
access to information that should, in
theory, be useful.
Researchers have in the past suggest-
ed that odds of 50:50 are really code for “I
don’t know”. That may well have been
what was going through Mr Obama’s
mind when faced with such a wide range
of estimates. Forecasters put odds on
events because words like “probable”
and “likely” are interpreted very differ-
ently by different people. But numbers
mean nothing without confidence.Odds and evens
Behavioural economicsWhy ar e people attracted to 50:50 probabilities?T
he world’soldest central bank, Swe-
den’s Riksbank, is a trendsetter. In July
2009, in the depths of the financial crisis, it
was the first central bank to cut interest
rates below zero. It set the global record, of
minus 1.25%, for the lowest interest rate on
deposits parked with it by domestic banks.
Now, however, it looks set to bring the ex-
periment to an end. On December 19th it is
widely expected to leave negative territory,
raising rates from minus 0.25% to 0%.
Since the economy is in the doldrums,
the rationale is unclear. Inflation is 1.7%
and forecast to stay below the target of 2%
for some time. Meanwhile, the most recent
figure for annualised gdp growth was a pal-
try 1.1%, and the purchasing-managers in-
dex, a measure of business activity, is at its
worst since the euro-zone crisis of 2012.
The words and actions of the Riksbank’s
five voting members seem to be all over the
place. At the most recent meeting, in Octo-
ber, all expressed concerns about the econ-
omy. Stefan Ingves, the governor, argued
for a more expansionary monetary policy,
noting that Sweden is particularly exposed
to weakening global trade. Yet he and his
colleagues agreed to the plan to raise rates
at the next meeting, on December 19th.
Lars Svensson of the Stockholm School
of Economics, a former member of the
Riksbank, attributes the move back up to
zero to ratesetters who have an “irrational
fear of negative interest rates”. But the most
recent monetary-policy report, in October,
assessed negative rates and concluded that
they have been a success for Sweden.
If neither the economy nor economists
seem to demand an end to negative interest
rates, where does the demand come from?
The minutes of the latest monetary-policy
meeting hint at a possible answer: the gen-
eral public. Henry Ohlsson, a member of
the committee, commented that “it has be-
come very clear that those who are not
economists believe it is strange that inter-
est rates can be negative.”
Moreover, the Riksbank is under fire for
its perceived role in causing Sweden’s cur-
rency to weaken. In February the krona hit
its lowest level ever in real trade-weighted
terms, notes Henrik Unell of Nordea, Scan-
dinavia’s largest bank. Nordea has dubbed
the Riksbank the “krona-killing monster”.
In March Mr Ingves brushed off such
criticisms. He wrote in Dagens Nyheter, a
daily newspaper, that the central bank
“cannot, and should not, stabilise both in-
flation and the exchange rate”. Since Swe-
den’s inflation target of 2% is in line with
most other countries’, he added, there was
no reason to think the krona would weaken
indefinitely. The currencies of other small
countries with substantial foreign trade
had also suffered, he said.
But the pressure continued. When Mr
Ingves arrived at a conference in Stock-
holm in May with three bodyguards, many
saw a link with public anger at the weak
currency—and, by extension, monetary
policymakers. “It’s embarrassing and pain-
ful to see how the Swedish crown contin-
ues to weaken against the euro,” tweetedCarl Bildt, Sweden’s prime minister from
1991 to 1994. Goran Persson, one of Mr
Bildt’s successors, has complained public-
ly about how cheap Swedish assets have be-
come for foreign investors.
Perhaps the Riksbank has been worn
down by all the criticism. It is one of five
central banks with negative policy interest
rates—including two giants, the European
Central Bank and the Bank of Japan. Nearly
a quarter of global gdp is supported by neg-
ative rates. If the Riksbank’s experience is
anything to go by, the great experiment
with negative rates will continue to unset-
tle people all over the world. 7A Nordic pioneer of negative interest
rates gets cold feet
Sweden’s monetary policy
The Riks flips