MILAN – While official sources and the media highlight strong consumer-spending and jobs data in the United States, or tout high US stock-market valuations, more than three-quarters of Americans view economic conditions as poor (36%) or fair (41%). This disconnect between performance and perception can have far-reaching consequences; it already helped to propel Donald Trump to victory in last month’s presidential election. So, what is causing it?
Here, it is worth considering how market participants deal with asymmetric information – when one party has more or better information than another party or parties. Imagine you were seeking to make a purchase. As a buyer, there is a limit to the information you can glean about your options through direct observation. So, you make your decision based on your beliefs about those options, which extend beyond discernible facts to include unseen or anticipated characteristics.
But the process is not finished when the transaction is complete. You then engage in “discovery” – essentially, observation. If, during this process, you learn things that do not correspond with the beliefs that drove your decision, you modify your beliefs.
In the signaling and screening models that economists use, the choices made by a variety of agents close information gaps and lead to equilibrium: the beliefs shaping demand lead to choices on the supply side that turn out to be consistent with those beliefs. The crucial point is that the direct observation that follows a transaction anchors beliefs and determines equilibrium.
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