Introduction
In "Narrative Economics," Nobel Prize-winning economist Robert J. Shiller explores a fascinating and often overlooked aspect of economics: the power of stories. Shiller argues that popular narratives - the stories we tell each other about the economy - can have a profound impact on economic events, from stock market crashes to Bitcoin bubbles.
Traditional economic analysis often focuses solely on numbers, statistics, and mathematical models. However, Shiller contends that this approach misses a crucial element: human psychology and the stories that shape our beliefs and behaviors. By examining how narratives spread and influence economic decision-making, we can gain a deeper understanding of why economies behave the way they do.
This book introduces the concept of narrative economics, which considers how popular stories affect economic outcomes. Shiller draws on a wide range of disciplines, including epidemiology, psychology, and history, to show how narratives can spread like viruses and shape economic events in ways that traditional economic models fail to capture.
The Power of Narrative in Economics
Narratives Drive Economic Behavior
Shiller begins by explaining that economists often speak in terms of figures, GDP, inflation, and other numerical indicators when discussing economic events. However, this approach neglects the human element - the fears, hopes, and beliefs that drive economic behavior.
Narrative economics seeks to fill this gap by considering the collective stories that influence how people make economic decisions. For example, the "shrewd businessman" narrative in the United States played a significant role in Donald Trump's successful presidential campaign. Whether or not Trump was actually a shrewd businessman is less important than the fact that he successfully tapped into this popular narrative.
Another example is the stock market crash of 1929. In the years leading up to the crash, stories of ordinary people becoming rich through stock market investments were widespread. These narratives encouraged more people to make risky investments, ultimately contributing to the market's collapse.
Shiller points out that while most economists have ignored the role of narratives, there have been exceptions. John Maynard Keynes, for instance, considered public sentiment in his economic analyses. In his book "Economic Consequences of the Peace," Keynes predicted that Germany would become embittered by the heavy reparations imposed after World War I - a prediction that couldn't have been made through purely quantitative analysis.
The Bitcoin Phenomenon
The rise of Bitcoin provides a perfect illustration of how narratives can drive economic behavior. While Bitcoin is based on complex mathematical principles, most investors are not drawn to it because of its technical aspects. Instead, they are captivated by the stories surrounding the cryptocurrency.
Bitcoin appeals to investors through several compelling narratives:
The promise of the future: Bitcoin represents a new way of doing things, distinct from traditional currencies associated with old institutions.
Technological sophistication: Investing in Bitcoin makes people feel they are part of an advanced, tech-savvy group.
Freedom from centralized control: Bitcoin appeals to those who distrust banks and governments, offering a currency outside their control.
International appeal: As a global currency, Bitcoin resonates with those who see themselves as citizens of the world.
Mystery and excitement: The unknown identity of Bitcoin's creator, Satoshi Nakamoto, adds an element of intrigue to the cryptocurrency's story.
These narratives have been instrumental in Bitcoin's success, attracting millions of investors despite the cryptocurrency's volatility and technical complexity. The Bitcoin phenomenon demonstrates how powerful stories can be in shaping economic outcomes.
Epidemics and Economic Narratives
Learning from Epidemiology
Shiller draws an interesting parallel between the spread of diseases and the spread of economic narratives. By studying how epidemics work, we can gain insights into how stories about the economy become "contagious" and influence behavior on a large scale.
In an epidemic, there are three key rates: the contagion rate (new infections), the recovery rate, and the death rate. An epidemic rises when the contagion rate exceeds the combined recovery and death rates, and it declines when this process reverses.
Similarly, economic narratives spread through various forms of communication - face-to-face conversations, social media, news outlets, and more. The "contagion" occurs as people share and discuss these stories. The narrative's popularity rises rapidly at first, then slows down as people lose interest or forget about it (analogous to recovery or death in an epidemic).
The Bitcoin Narrative Epidemic
The Bitcoin phenomenon again serves as an excellent example of how economic narratives can spread like epidemics. By tracking the frequency of the word "Bitcoin" in news and newspapers worldwide over the past decade, we can see a pattern that closely resembles the shape of a disease epidemic:
- A rapid increase around 2013
- A sudden spike and peak in 2018
- A decline following the peak
- Secondary "waves" after the initial spike
This pattern demonstrates how economic narratives can follow similar trajectories to disease outbreaks. Understanding these patterns can help economists and policymakers anticipate and respond to the spread of influential economic stories.
Narrative Constellations
Interconnected Stories
Shiller emphasizes that narratives rarely exist in isolation. Instead, they often form part of a broader network of related stories, which he calls "narrative constellations." These interconnected narratives can reinforce each other, making the overall story more compelling and influential.
The Laffer Curve theory provides an excellent example of how narratives can work together:
The initial idea: Arthur Laffer's theory suggested that lower tax rates could lead to higher tax revenue.
The origin story: The famous anecdote of Laffer sketching the curve on a napkin for Republican politicians Donald Rumsfeld and Dick Cheney gave the theory a memorable backstory.
Political context: The Laffer Curve aligned with the anti-big government sentiments promoted by politicians like Ronald Reagan and Margaret Thatcher.
Cultural reinforcement: The popularity of Ayn Rand's novels, which criticized government interference in the economy, provided additional support for the Laffer Curve narrative.
Each of these related narratives lent weight to the others, creating a powerful constellation of ideas that influenced economic policy and public opinion.
The Importance of Context
Understanding narrative constellations is crucial for grasping the full impact of economic stories. By examining the broader context and related narratives, we can better comprehend why certain ideas gain traction and influence economic behavior.
For example, the narrative around government inefficiency and high taxation doesn't exist in a vacuum. It's part of a larger constellation that includes stories about individual liberty, free-market capitalism, and distrust of centralized authority. Recognizing these connections helps explain why certain economic policies gain popularity or face resistance.
The Power of Vivid Details
Human Minds and Narrative Formation
Shiller points out that humans have a natural tendency to form narratives. We constantly shape our experiences into stories, as noted by philosopher Jean-Paul Sartre: "a man is always a teller of tales...he sees everything that happens to him through them."
To create these narratives, our minds often latch onto particular, vivid details. These details, even if seemingly irrelevant, can have a significant impact on how we perceive and remember events.
The Guacamole Effect
Shiller cites a 1985 experiment by cognitive psychologists Brad E. Bell and Elizabeth F. Loftus to illustrate this point. In the study, participants acting as jury members were presented with fictional court cases, some of which included vivid but irrelevant details.
In one case, the accused was said to have "knocked over a bowl of guacamole onto the white shag carpet" during the crime. This small detail, despite its irrelevance to the case, helped the experimental jury form a more concrete picture of the events and influenced their decision to convict.
Economic Narratives and Vivid Details
In the realm of economics, vivid details can similarly shape narratives that have significant effects. Shiller provides the example of the 9/11 terrorist attacks and their impact on the U.S. economy:
Pre-attack context: The U.S. was in the middle of a recession.
Initial expectations: Many economists feared the attacks would further erode economic confidence.
Surprising outcome: By November, the recession was over.
The power of vivid imagery: The dramatic visuals of the attacks on symbolic buildings like the World Trade Center and the Pentagon created a powerful narrative.
Leadership response: President George W. Bush's speech encouraging Americans to "Do your business around the country. Fly and enjoy America's great destination spots" provided a vivid call to action.
These vivid details helped Americans construct a narrative of resilience and recovery, spurring them to resist the expected economic slump. This example demonstrates how particular, memorable elements of a story can shape economic behavior in ways that defy conventional economic predictions.
Perennial Economic Narratives
Recurring Themes in Economic Storytelling
Just as literary critics have identified recurring plot structures in stories, Shiller argues that there are perennial economic narratives that appear repeatedly throughout history. These recurring themes shape how we understand and respond to economic events.
Panic vs. Confidence
One of the most common economic narratives is the struggle between panic and confidence. This story has deep roots in American economic history:
1857 Financial Panic: The idea of financial panic gained popularity in the lead-up to the U.S. Civil War.
1907 Panic: The use of the word "panic" to describe financial crises peaked after this famous event, which involved celebrity banker J.P. Morgan using his own money to bail out the banking system.
Coolidge's Confidence Boost: In the 1920s, President Calvin Coolidge gave optimistic public addresses about the economy to bolster confidence in the stock market, even when the reality was less rosy.
The panic vs. confidence narrative has remained a crucial part of economic storytelling. During the 2008 financial crisis, for instance, the historical memory of previous panics played a significant role in shaping public perception and response.
The Stock Market Crash
Another perennial narrative is that of the stock market crash. This story gained prominence with the 1929 crash, which introduced the dramatic use of the word "crash" to describe a sudden, severe market downturn.
The stock market crash narrative resurfaced powerfully during the 2007-2009 Great Recession. As in the 1920s, the idea that the crash was an inevitable punishment for a period of reckless speculation became popular.
The Importance of Recognizing Perennial Narratives
Understanding these recurring narratives is crucial for several reasons:
Historical context: Recognizing perennial narratives helps us understand current events in the context of historical patterns.
Predictive power: Familiarity with these recurring stories can help economists and policymakers anticipate how people might react to similar situations in the future.
Critical analysis: Awareness of these narratives allows us to critically examine whether they accurately describe current economic conditions or if they're being applied inappropriately.
Policy implications: Policymakers can use knowledge of these narratives to craft more effective communication strategies and economic interventions.
By recognizing that what we're experiencing is often a mutation of one of these perennial stories, we can gain a deeper understanding of current economic events and their potential outcomes.
The Evolution of Economic Narratives
Changing Perceptions Over Time
Shiller points out that our collective understanding of economic events can change significantly over time. Just as personal memories can be reinterpreted and reshaped, economic narratives can evolve, altering our perception of past events and influencing our responses to current situations.
The 1987 Stock Market Crash
The memory of the October 19, 1987 stock market crash provides an excellent example of how economic narratives can change:
The event: It was the largest one-day crash in percentage terms in history.
Immediate narrative: At the time, there was much discussion about a computerized trading program called portfolio insurance, which was believed to have exacerbated the crash.
Evolving perception: Over time, the specific circumstances of the 1987 crash have been forgotten by many.
Current impact: The memory of the crash still affects investor confidence today, even though market conditions are very different.
This evolution demonstrates how the narrative surrounding an economic event can become disconnected from its original context, yet still influence current behavior.
World War I and II: Changing Investment Narratives
The changing narrative around wartime investing between World War I and World War II illustrates how evolving stories can lead to dramatically different economic behaviors:
World War I response: Investors reacted with panic and irrationality. European investors shipped massive amounts of gold out of the United States, and the stock market fell steeply.
World War II response: When World War II began on September 3, 1939, the S&P stock market index rose by 9.6 percent.
Narrative shift: Between 1918 and 1939, a new narrative emerged suggesting that those who had held onto investments during World War I had become wealthy.
This dramatic shift in narrative led to entirely different investor behavior at the outset of World War II, demonstrating the powerful influence that evolving stories can have on economic decision-making.
Implications of Narrative Evolution
Understanding how economic narratives change over time has several important implications:
Critical analysis: We should critically examine our current understanding of past economic events, recognizing that our perceptions may have been shaped by evolving narratives.
Contextual interpretation: When applying lessons from historical economic events, we need to consider the original context and how the narrative has changed since then.
Anticipating changes: By studying how economic narratives have evolved in the past, we may be better equipped to anticipate how current stories might change in the future.
Policy considerations: Policymakers should be aware of how changing narratives can affect public perception and economic behavior, adjusting their strategies accordingly.
Harnessing Narrative Economics for the Future
The Importance of Narrative Research
Shiller argues that to better predict and prepare for economic events, economists must take narratives seriously. Traditional statistical analysis, while valuable, is not sufficient to capture the full complexity of economic behavior.
Tools for Narrative Analysis
Modern technology provides unprecedented access to data that can help us understand economic narratives:
Internet searches: Analyzing search trends can reveal what economic issues are occupying people's minds.
Social media analysis: Studying social media conversations can provide insights into public sentiment and emerging narratives.
Focus groups and market research: These traditional tools can offer deeper understanding of how people perceive economic issues.
Text analysis: Advanced software can search through vast amounts of text data (books, newspapers, online content) to identify key words, phrases, and patterns related to economic narratives.
Interdisciplinary Approach
To effectively study economic narratives, Shiller recommends drawing on insights from various disciplines:
Humanities: Lessons can be learned from fields that specifically study narrative, such as literature and cultural studies.
Neuroscience: Understanding how the brain processes and responds to stories can inform narrative economics.
Psychology: Insights into human behavior and decision-making are crucial for interpreting the impact of narratives.
Artificial Intelligence: AI techniques can help identify patterns and connections in large datasets of narrative information.
Practical Applications
By better understanding narratives, policymakers and economic leaders can more effectively shape public behavior during economic crises or transitions:
Crisis management: Like President Roosevelt's "fireside chats" during the Great Depression, leaders can use narrative techniques to boost confidence and guide economic behavior.
Proactive policy-making: By identifying emerging narratives early, policymakers can develop strategies to address potential economic issues before they become crises.
Improved forecasting: Incorporating narrative analysis into economic models could lead to more accurate predictions of economic trends and events.
Public education: Understanding common economic narratives can help in developing more effective financial literacy programs.
Conclusion
"Narrative Economics" presents a compelling case for the importance of stories in shaping economic events. By examining how narratives spread, evolve, and influence behavior, Shiller offers a new lens through which to view and understand economic phenomena.
Key takeaways from the book include:
Economic narratives can spread like epidemics, following similar patterns of contagion and decline.
Stories often work together in "constellations," reinforcing each other and creating powerful influences on economic behavior.
Vivid details play a crucial role in making economic narratives memorable and impactful.
There are perennial economic narratives that recur throughout history, shaping how we interpret and respond to economic events.
Our understanding of economic narratives can change over time, altering how we perceive past events and react to current situations.
By studying and understanding economic narratives, we can better predict and prepare for future economic events.
Shiller's work challenges economists and policymakers to look beyond traditional quantitative analysis and consider the power of stories in shaping economic outcomes. By integrating narrative analysis into economic thinking, we may gain a more comprehensive and nuanced understanding of how economies function and how to navigate economic challenges.
As we move forward in an increasingly complex and interconnected global economy, the insights provided by narrative economics could prove invaluable. By recognizing the stories that drive economic behavior, we can work towards creating more resilient economies and developing more effective strategies for addressing economic crises and opportunities alike.