The elite overproduction hypothesis

But expectations matter. In the finance world, a number of economists have recently been playing around with the idea of “extrapolative expectations”. Basically, when a trend goes on long enough, people start to think there’s some sort of structural process underlying the trend, and therefore they assume the trend will continue indefinitely. For upwardly mobile people, or people in an economy that’s growing rapidly, or people whose stocks or houses are appreciating steadily in value, good times might come to seem normal.

And then what happens when it turns out that good times aren’t baked into the nature of the Universe? Suddenly, the mediocrity of reality intrudes upon the complacent expectations of eternal upward growth — housing prices plateau or fall, incomes hit a ceiling, economic growth stalls out. At this point, people could get quite angry. The economists Miles Kimball and Robert Willis have a theory that happiness is just the difference between reality and expectations. If things are better than you predicted, you’re happy; if things are worse, you’re upset. Kimball and Willis formalize the idea with math, but in fact “Happiness = Reality – Expectations” is already a common saying. Evidence from surveys generally supports the idea.

Together, this expectations-based theory of happiness, along with the idea that expectations are extrapolative, makes for a combustible mix. Extrapolative expectations are almost always unrealistic — growth trends don’t continue forever, so people are setting themselves up for disappointment.