Daniel Kahneman on the Intersection of Economics and Psychology

Dr. Daniel Kahneman, winner of the 2002 Nobel Memorial Prize in Economics, joins us to discuss his book Thinking, Fast and Slow.

When economists rubbed elbows with psychologists 40 years ago, assumptions were challenged. Kahneman has spent much of his career examining those assumptions to better understand the effects of human psychology on the field of economics. The full version of the interview can be seen here. A full transcript follows the video.

Morgan Housel: We're very lucky today to have Dr. Daniel Kahneman with us. He is a psychologist from Princeton University. He's the author of the book Thinking, Fast and Slow. He's been called "one of the most influential psychologists since Sigmund Freud." He won the Nobel Prize in Economics in 2002. Please welcome Dr. Daniel Kahneman.

Dr. Kahneman, you won the Nobel Prize in Economics, but you're not an economist; you're a psychologist. From what I understand, that's the first time that's ever happened in that award for economics.

To me, that's a confirmation that so much of what is important in economics and in investing has less to do with numbers and spreadsheets and Greek formulas as it does what's going on in our head, and fooling ourselves.

Just to get a background of your career, from what I understand the first time that your work intersected with economics was in the early 1970s, when a colleague brought to you an economics paper and the first line of the paper was, "The agent of economic theory is rational, selfish, and his tastes do not change." For a psychologist, that's ridiculous, so what happened next?

Daniel Kahneman: Well, nothing happened immediately, but I found that very surprising, actually, because the economics building was next door. I was at Hebrew University, Jerusalem, and we had one building, and the economists were next door. I learned from that one sentence something I hadn't know before -- that they sort of lived in a different intellectual world than we did.

For a psychologist it's obvious that people are not fully rational, and that they're not selfish, and that their tastes change. It was just a collection of statements that seemed almost absurd. I had no idea, at that stage, that a lot of my career would be dedicated to that conversation. That sort of happened almost by accident, later.

Housel: In the last decade, behavioral economics has grown in influence. It's much more accepted now than it was in the past. I guess my question is, why did it take so long?

Kahneman: It didn't take long. Twenty-five years is a blink of an eye, in intellectual developments. Our first serious paper appeared in an economics journal, Econometrics, in 1979. It appeared there by accident. We were not intending to influence economists. It was the best journal for this sort of theory paper.

I think my Nobel was 2002. That is very, very, very quick. They had two Clark medals. You know, the Clark medal is really more prestigious than the Nobel in economics. It's given to the best economist under 40, and they had two behavioral ones. Twenty years is very, very fast.