Soros on the crisis
From an interesting article in The New York Review of Books (the usual caveat that all I'm trying to do is learn this stuff, like most of us).
First, the dominant paradigm, "rational expectations":
Lucas, the third member of the Chicago triumvirate, was arguably more influential even than Friedman. In a series of ingenious papers published in the 1960s and 1970s, he and several colleagues extended the hyperrational methodology underpinning the efficient markets hypothesis to other parts of the economy, such as the job market, the output decisions of firms, and the formulation of economic policy. By the time they were done, Lucas et al. had invented a new way of doing macroeconomics, known as the rational expectations approach, which enshrined in higher mathematics the stabilizing properties of unfettered markets. You don't have to spend much time on Wall Street to recognize that expectations are what drive the markets. If investors anticipate good news, they buy; if they expect bad news, they sell.
Where, though, do these economic expectations come from? According to Lucas, they reflect a predefined, externally grounded, and commonly agreed upon reality. In his models, the economy's equations of motion are well defined and known to all—from Ph.D. economists at the University of Chicago to nurses and cab drivers. Utilizing this common knowledge, people form "rational expectations" of things like inflation and interest rates. They don't always get things right—a certain amount of randomness is allowed for—but they are precluded from making systematic errors. If in one period the economy gets out of sync, in the next period it jumps back to the "equilibrium" defined by the model.
Soros disputes rational expectations theory, promoting a theory called "reflexivity" instead:
Outside the idealized world of Lucas's theory, knowledge is imperfect, people stick to wrongheaded ideas, and there is no agreed version of how the economy works. In these circumstances, Soros rightly points out, economic expectations, even biased ones, can help to determine economic fundamentals. ...
Reflexivity can be interpreted as a circularity, or two-way feedback loop, between the participants' views and the actual state of affairs. People base their decisions not on the actual situation that confronts them but on their perception or interpretation of that situation. Their decisions make an impact on the situation (the manipulative function), and changes in the situation are liable to change their perceptions (the cognitive function).
A simple hypothetical example—for which I also take responsibility—may help to illustrate what can happen in such a reflexive system.
The reviewer gives a worked example (see the link) but I can't summarize it because the finance jargon makes my head hurt. But it sure makes the "go go 70s" seem familiar.
As for the "manipulative function" -- I take it that the people who "create our own reality" are in charge of that? Or is that everybody?