What is Reflexivity?

Reflexivity refers to the fact that the feedback loop is common in Economics. It suggests that the investor’s ideas have a great impact on economics, which again impacts the perception of the investor. Though reflexivity is one of the common concepts of sociology, it is mainly used in the financial and economic world. George Soros happens to be the first person to support this theory.

According to Soros, the concept of reflexivity contradicts nearly all the major economic concepts. He also believes that reflexivity must be considered as the researcher’s main focus. Soros has also claimed that reflexivity is one of the few economic and financial concepts that can change all the basic principles of Macroeconomics. If it is used as the prime element of research, then reflexivity can lead to the development of unique epistemology. Let’s get into the detail of reflexivity and its impact on Economic Equilibrium.

Soros’s Views on Reflexivity

In simple terms, reflexivity is based on a theory that people are highly likely to make decisions that are based on their views rather than reality. They base all their investment decisions on what they believe to be the reality. These actions can affect fundamentals. As a result, it changes the perception of the investor.

This creates a feedback loop, where the investor’s view and decisions impact the economic fundamentals, which changes the investor’s views. This feedback loop can affect the Economy as a whole. Not only the investment Industry, but the prices of all goods and services are affected by this continuous feedback loop. Eventually, it gets to a stage where the prices of the financial instruments and other local products get totally disconnected from reality.

How Does Reflexivity Affect Economic Equilibrium?

This process creates disequilibrium. Soros explained the concept with an illustration by mentioning that how the high prices of the real-estates encouraged financial institutions and credit unions to increase home loans, which led to a further increase in the prices of the Real Estate in that region. With the incredibly high prices of real estate and increased mortgage lending, the economy ends up in a financial crisis. This is one of the common causes of the economic Recession.

George’s claims concerning the accuracy of the reflexivity do not fit with the economic equilibrium. He believes that the prices of the products and customer’s expectations share a strong connection. The investor’s perception can drive the prices up and down significantly over time.

As mentioned before, the reflexivity concept contradicts mainstream economic principles. If the Bank or the financial institution had considered the Market supply and demand Factor before making a decision, the economy would not have collapsed. It isn’t always the investor’s perception of the reality that matters. The decisions must be based on the actual economic factors instead of some random perceptions. The investor’s perception can never lead the economy towards an equilibrium state. The focus must be on the current trends, customer demands, market supply, resource availability, and other such tested and proven economic fundamentals.