AI, The Great Depression And Satoshi Nakamoto: Robert Shiller’s Narrative Economics Is A Cautionary Tale For Our Times
Yale University’s Nobel Laureate professor of economics, Robert Shiller has published a provocative new book advancing the idea that stories or narratives that spread like epidemics, have a bigger impact on our economy than most in his profession—who are typically constrained by rigid quantitative techniques—consider in their theories. He believes that the so-called dismal science should be taught with a bigger dose of the humanities—namely history and psychology. Of course many successful investors have long known that a good story can move markets and, in fact, many of the manias of recent years, like the housing bubble of the early 2000s and the bitcoin craze of 2017, as Shiller points out in his book, relied on narratives that had a significant impact on economic activity. Dr. Shiller, of course, is well known for a previous best-seller, Irrational Exuberance, which essentially predicted the dotcom and housing bubbles (in its first, then second edition) and for his Case-Shiller Home Price Indices.
Shiller’s new book, Narrative Economics: How Stories Go Viral & Drive Major Economic Events (Princeton University Press, 2019), is especially timely in the current social media-obsessed era, because narratives—both real and false—can spread globally with just a few swipes, affecting not just economic activity, but ultimately the balance of geopolitical power.
Below is a transcript of a recent discussion with Dr. Shiller where we hit on topics ranging from bitcoin and the French and Indian War to artificial intelligence and Karl Marx.
What made you write Narrative Economics?
When I was 19, I was taking both economics and other courses, I think a history course. The professor assigned a book about the 1920s published in 1931, about the beginning of the Great Depression. And I thought there’s something here I’m not hearing in my econ courses. There is something about how people think, observations of how they think. And sometimes they have ideas that look a little silly, but maybe they’re not. They don’t look respectable but it might affect their thinking. And all my life, since then, I’ve been a little bit disappointed. I like economics, and I like mathematical economics, but I felt a little disappointed. You never talk about what people are saying or thinking. In trying to analyze events like the Great Depression. It seems like you’re missing something. And then, the next thing is to read about epidemiology. There’s a big medical literature, so ideas spread like epidemics.
It goes back in my lectures. I taught a course called Behavioral and Institutional Economics, a graduate course, for many years. And I got students from all over the university. It was more of a humanistic. I guess I was influenced by C.P. Snow. He wrote an essay, a short book, in the 1950s called Two Cultures. In that book he argued that academia is split between the scientists and the humanists, and they can’t comprehend each other. And that’s kind of what I was getting at; that historians are humanists. Although now there are some experts in cliometrics. Clio is the goddess of history, so they invented Cliometrics which is quantitative history. They look for numbers and do statistical analysis, which is fine, but I was looking at another aspect of history. That the world is viewed differently at different times in history and in different cultures. And I think you do better as an economist if you take that into account.
So you think that economics has leaned more towards the metrics, the science, the numbers?
Especially when I was in graduate school, in the second half of the 20th Century, mathematical economics of a very pure type was very prestigious.
Was that Samuelson?
Yes, I had Samuelson as my teacher and I liked him a lot, and he wasn’t indoctrinaire at all. There was a behavioural economics revolution, which started around 1990, that was bringing in psychology. So maybe my book is part of that revolution. On the other hand, it suggests a different research in general. The typical behavioural economist will do some experiments, he’ll put 20 students at computers and ask them to trade and they’ll manipulate something to reveal something about human nature and how people play games. That is really good but it’s not exactly what I call narrative economics.
I’m thinking that narrative economics will come into its own in the coming years because it can exploit digitized text. And it’s already becoming a fad, in a sense. A lot of it is aimed at marketing or stock picking, but I think it could be more thoroughly blended into economics. So I actually, with George Akerlof, had a series of seminars called Behavioural Macroeconomics. You’d think that psychology would matter for business cycles, but it hasn’t taken off yet but I think it will.
Has social media and the ubiquity of instant information had an impact on your decision to write the book now?
Yes, social media couldn’t be more prominent. With our tweeting president, for example, and the immediate responses. It speeds things up. But I’m arguing in my book that the epidemic quality of narratives goes back thousands of years, it’s not new. It did move history even thousands of years ago. But one thing that’s different now is that with social media people find like-minded people to befriend more easily, so it involves more splinter groups that have more idiosyncratic views. Because you can choose to associate with people who share a fascination with something, it can cause radicalization. So I mean the obvious example right now is mass shootings.
How do you determine which narratives actually will have significant economic impact and which ones are just noise?
I’m working on that. What I’m doing now is studying history and looking at things that were often mentioned. And to get the actual causal link, so what caused the Great Depression? I’m inspired to not give up because I don’t think people know. There’s been so much written about the Great Depression, but what caused it? There are theories, but they’re no more convincing than my theories.
Do you suspect that the Great Depression might have had a narrative that may have contributed to the Great Depression?
Multiple narratives. See, the Great Depression was great because it was like a perfect storm, a number of narratives all encouraged people to cut back on their spending. So I talk about some of them in the book.
Was the Great Recession also narrative-driven?
I think so. In both the cases of the Great Depression and the Great Recession, the preceding decade had a bubble narrative that eventually collapsed. There were skeptics who weren’t heeded during the 1920s and the 1990s, up till 2007. But then they eventually got contagious enough. It’s not possible to just be a skeptic when you’re talking to true believers in the economic new era. They may just not be interested, you can’t get their attention. You need a concrete narrative that is viable. Those things are inventions. So talk of the housing bubble in the case of the Great Recession began around 2005, a couple of years, and it took a while to take root, I should say, to become fully contagious.
The difficult thing, especially for policymakers or market players, is to determine when a narrative should be taken seriously or when to take action based on a narrative?
Right. Well, I think there was some intuitive feel for that. In the Great Depression it generated narratives about bank runs. People thought bank runs were cured by the Federal Reserve (established in 1913); the Federal Reserve wouldn’t let it happen. But here it was happening in the 1930s again, so it brought back an older, 19th Century, narrative. And it was catastrophic in 1933 when the bank holiday had to be declared. And then they created deposit insurance and that was supposed to cure these things. But then people noticed there was a maximum amount that was insured. If you had more than that you could still lose in a bank run. So that’s the kind of thing you had with Britain’s Northern Rock in 2007, and then in other banks in the United States in 2008. It was the old narrative coming back. They tend to recur. You can forget about them for a while but they’re in the background, and something happens and it looks plausible again. So we almost had a bank run, then the Fed had to take extreme measures and to justify these measures they had to talk tough about a possible depression. And that’s what happens when the narrative of the Great Depression was brought up again sharply in 2007. People didn’t know all about the Great Depression, they just remembered people that were destitute, they were selling apples on the street corner, they made a bare sustenance living. They remember that…Apples 5 cents. They had a little sign that said “Apples 5 Cents,” help me I’m unemployed I need help. That was a visual image. So that had a lot of contagion.
It’s just like the visual image we have of people jumping out of buildings during the Great Depression. The thing is now we have false narratives and memes reinforcing them. Narratives can take hold, and it seems like our President is a master of narratives.
How do you create policy or deal with something like that?
The problem is that a narrative that has taken flight that the mainstream media is lying and deceitful and is controlled by the deep state who tells them what to say. This narrative already has different forms but it encourages skepticism at the same time that we have alternative news media that appeal to narrow groups.
In your book you discuss Keynes theories, where fiscal stimulus creates the multiplier effect of economic activity. Is Narrative Economics a revision of this theory, instead of say, fiscal stimulus, the stimulus is in the form of a widely accepted narrative or idea?
Yea, I talk a little bit about this in my appendix in the book. The multiplier theory was part of Keynes’ General Theory. Economists liked it because it involved no psychology. It’s just mechanical re-spending, multiple rounds of expenditure. It obviously has an element of truth to it. Many times. But it’s a feedback loop, that’s the Keynes theory. If the government spends money, it creates income for some people who are using the services. And then they spend money and that becomes income for someone else, it multiplies up. But I think there are other kinds of multipliers, or feedbacks. An epidemic model is a kind of feedback model. Somebody gets sick with a rare illness and then conveys it to someone else, and then there’s a second round of sickness that is then conveyed. So I use the term pro-epidemic, a term from epidemiologists. There are also disease epidemics that feed back into each other. So if you catch AIDS, that makes you vulnerable to tuberculosis. And so you start spreading tuberculosis and now you have two epidemics interacting with each other. And I think that’s kind of the way macro events are. So if the government creates some fiscal policy for a depression, they have to announce it and they have to say something. Unfortunately, what they say matters, I’m arguing. If they say, we are panicking because it looks like a coming depression so we’re trying to stop it, that might actually offset the advantage of the new policy. People who are getting the round of expenditure won’t spend it.
So it’s almost like the economics of spin. In what way do you foresee economic narratives as being a tool for the prediction of major market developments, including recessions? How reliable is the data, given that news often follows events.
I wrote a paper in the Brookings Paper in 1984 called Stock Prices and Social Dynamics. And in that paper, I was already talking about epidemics. I don’t know if I used the word epidemic but it was sort of in there. And I was confronting the idea that market efficiency shows that markets are not bubbly. That they are responding, that they are incorporating information. I had an idea that it could be, in fact, that markets are not responding to information about anything fundamental, they are reacting to information about people and their psychology. And it was still hard to predict the market in the short run. So that was an important element in my thinking.
Is there work being done on models to use your Narrative Economics to either help predict economic moves or as a policymaking tool possibly?
Well, there are a lot of people, it’s hard to summarize all of them. There’s a lot of statistical analysis of digitized text, and often these people are trying to predict the markets. I think that’s great, I do that too.
Because hedge funds, for example, will now monitor Twitter and monitor narratives. They’ll trade off those narratives and they have been for a long time. It just seems like now more than ever there is a lot of risk of certainly false narratives given these, as you say, echo chambers that are established.
I think that what I’m trying to do in this book is describe what’s happening in the future in economics. That there will be more of this and I think it should be, and probably will be, not so focused on stock picking and marketing, because it infects all of economics. The economists like to use the paradigm actually first clarified by Samuelson. That we’ll describe people as intertemporal utility maximisers, with a consistent utility function and never change their mind about it. Part of what happens is that they even change their case in response to narratives. So in the book I talk about the Great Depression and I quote various people from back then. And I say that in the depression it just didn’t feel right to consume a lot of luxury goods, even if you could afford them. So new car sales in the Great Depression fell catastrophically. Between 1929 and 1932, I think it was. In the book, there was an 86% drop in Ford car sales, new Fords. And I think the reason is, if you live in a neighborhood where next door there is someone who is out of a job and they are having trouble feeding the kids, you don’t buy a shiny new car and park it in your driveway.
It’s the conspicuous consumption dilemma?
Yes, so Therstein Velben wrote a book in 1899, called the Theory of the Leisure Class. By 1930, he had become radicalized. But the original book was influencing a lot of people’s thinking. People will view consumption as show-offy. But it kind of was not so prominent in the 1920s. You could show off. The Roaring 20s. Everyone was having fun, a great time. Not everyone though.
Our president has a history of showing off his wealth. So perhaps there will be a return to that?
He wrote about it. He and his coauthors wrote about it in various books. He advises it’s good business sense to show off. I found an essay in Ancient world, in Greece, by Lucian. A professor of public speaking. Second Century. And he tells you to behave like Donald Trump, it’s amazing. He says, when you show up at a Forum to give a speech. Always show up with a retinue. You don’t just go in by yourself, and he said, you want to make it look like women are fawning over you. Keep that image going. So it worked in Ancient Greece.
Do you think that these narratives could also be used as a policy tool going forward?
Yes, I think they already are. Fed Chairman Ben Bernanke, when there was a first bank run in the United States (during the Financial Crisis), was aware that the narrative would come back in the economic contagions. Narrative Economics is not something that he espouses, but on the other hand he does take a look at history. He wrote a whole book on the Great Depression, and he does have some appreciation of the effect of narratives. It’s kind of common sense that you don’t want people to panic. And so if you are panicking you want to be reassuring. So unfortunately you’ve also got to, in order to justify what you’re doing, paint a picture of danger, don’t worry. But you want to be reassuring about it.
How are policymakers influenced by economic narratives? Do you believe that they tend to follow them in order to appeal to voters?
Yes, that’s a problem.
They’re not just policymakers, they’re politicians.
They have to be. Another theme is that the famous names that we have, the celebrities, are products of epidemics. There is something contagious about what they do, and what their story is. So, for example, a story has to be just right to be contagious. A Congressman in 1896 gave a speech in Congress and there were reporters there, and William Jennings Bryan was in the audience, it’s known. And he made this dramatic statement in his speech about the gold standard and he said, “Thou shalt not crucify us on a cross of gold” referring to the gold standard. Nobody paid any attention to that quote. But WJB (already known for his orations) on his accepting his Democratic nomination for President at a Democratic Convention in 1896, at the very end of his speech he rose his arms like this in some sort of religious symbol: “Thou shalt not crucify mankind on a cross of gold” and the audience, reporters and convention looked stunned and silent for a minute, and they broke into a round of cheers and they carried him off the stage like a hero. That was a contagious story. And people still remember that quote today. It’s not just enough to say it, it has to be said by the right person at the right time and part of a story. He didn’t win the election, it would’ve changed history if he did.
What narratives are going to shape the future? What big narratives will change economic activity?
This is the real question, how to predict that. One such narrative that strikes me as possibly important:. If we do have a recession, is the “technological unemployment” narrative that, I’m using the name for it that prevailed during the Great Depression. The idea is that machines are replacing jobs at such a pace that only a few lucky people will be able to have employment. There is a lot of talk now about artificial intelligence and about rising income inequality. But it hasn’t really gotten people scared yet. Consumer spending is good. They’re not afraid to buy a new car.
People are thinking about their own prowess in playing computer games or something. So it feels empowering. I’m just saying I can’t predict what the next big narrative, damaging narrative will be but it could take a turn.
What about cryptocurrencies and bitcoin narratives?
Cryptocurrencies are a fascinating invention. They create a temporary, at least, equilibrium of created value out of nothing. The question is where is it going? I don’t answer that question in the book. I think that computer scientists, and certainly passwords, if you think about crypto-something is unfortunately a very large part of our lives. I don’t know if bitcoin will ever be used as a currency. But what I talk about in the book is that the reason for the excitement about it, and why did it create so much value?
You would think the original paper by Satoshi Nakamoto would be a kind of nerdy, technical paper that didn’t interest anyone. But people are fascinated by it. I think it’s because the story links into some deep fears, or emotions, and also because it has good story quality. The story quality is that nobody can find Satoshi Nakamoto, it becomes a mystery story. Why did he do it? Where is he? Is he one of the richest people in the world and why doesn’t he show himself? People like mystery stories, it’s a genre.
Like religious narratives are often mysterious.
Right. That was emphasised by Pascal Boyer in his book Religion Explained. Don’t read it if you’re religious. He says that things that sound impossible actually propel religion because people like to tell controversial stories.
In your biography, you talk about your love for science from an early age. Does your theory of narrative economics have good science in it? Does it satisfy your need for scientific rigor?
It is a little bit on the humanistic side. It’s arguing against pseudoscience. You know, people want to pretend that this is theoretical physics and they’re finding that it’s not. I don’t want to use the term pseudoscience too aggressively, a lot of it is very good, I like it. It’s just that we have to recognize it doesn’t quite fit the information. I thought as a core premise of science that you’re going for the truth. And you do have to make simplifications, and you’ll test models that don’t fare out completely. Still there has to be some impulse towards accommodating facts into your models. And so there is still work to be done. And it seems that professions develop a professional espree that diminishes other fields too much.
How has the academic community responded to Narrative Economics?
Well, I believe I’m getting a positive response. It seems that people are interested. And even though I haven’t created a groundswell of new research yet. But I think people have already been doing research, and it legitimizes itself. I’m encouraging them also to think less mechanically. Somehow, it seems to me like narratives in this stage in history still have to be a bit of human judgement. About whether it might be motivating people. So why did consumption crash after the 1929 stock market crash? Christina Romer has a famous paper about the 1929 Crash that found that October 28-29, 1929, and she found that retail sales cut off almost immediately. And she said that can’t be the multiplier effect because their income hadn’t fallen yet. So it seems like there was a direct—I looked up why would it fall after Monday and Tuesday of that week or the next week or the next week. So I looked up Church sermons, and they tend to be moralizing and interpreting it as the day of judgement or something. So there was anyone who didn’t listen to the radio, and didn’t hear about the crash, would be warned about it from their church.
And then there was a widespread pullback in spending?
There was a widespread pullback right away. And I interpret that as also partly the building of a counter-narrative that was taking place already in 1929. So there was talk of high unemployment already before the 1929 Crash, it was starting to come up. It was commonly attributed to technological unemployment.
When researching the book, what was most fascinating/interesting/surprising narrative you came across?
What fascinates me, what comes to mind, is I found a letter to the editor, it says, letter to the printer of a newspaper in 1765 by a man—I think it’s a pseudonym, Alexander Windmill, about all the talk that was going on in 1765, and that was a recession year. It’s not in the NBER list of recessions because they don’t start until 1854. This was almost 100 years earlier. And it took place that the recession was caused as the aftermath of the French-Indian war, also called the Seven Years War. Which you may have never heard of. Anyway, there was a recession after the war. You heard this expression: “there is no money:” so many times, everyone must be saying this. And he described how a person was saying it. He said in the colonies, before the United States of America, he estimated that this phrase is repeated 50 million times a day. I was impressed by that, that he would come up with a number that big. Because I think there were only about 3 million people in the Colonies. So they would have to be saying it an awful lot. I think maybe he exaggerated. It was, in my mind, kind of vivid, that when you think of pre-revolution America, you think of the Pilgrims. But actually they didn’t have social media for sure, but they could talk and ideas could spread. Maybe it was only 1 million times a day. And I don’t know what they meant, biut “There is no money.” Some monetarist theory.
Are the implications of narrative economics that the biggest and strongest of storytellers are most effective at spreading ideas will have the most impact on economic activity?
I don’t want to be too pessimistic, you know, we do have modern society which does respect it. And I’m thinking of the medical profession. How often do they do worthless stuff? Someone wrote a book, I can’t remember who it was, explaining that the good stuff physicians do began to outnumber the bad stuff around the middle of the 19th century. Before that, you’d be better off not going to the doctor. They would not use sterile equipment. But now it’s pretty clear that medical physicians expanded life spans, and you trust them when they say you need an operation, you just do it. And that’s a sign that there is an element of truth that is recognized, even if they can’t explain to you why you need this operation. It’s subtle. But on the other hand, there is, especially when you move away from the professions and you get to things people don’t know much about, they certainly are vulnerable to fake news.
So you’re saying that eventually the narratives become more truthful? And that the risk of negative consequences is less or the way of verifying will get better?
Well, I don’t have any optimistic tone that things will get better. I’m a little worried at this time of the proliferation of social media that we may be going in a bad direction.
Is that part of the reason you chose to write the book?
Why did I write the book? It came out of a book I wrote with George Akerlof called Phishing for Phools. It also came out of another book I wrote in 2000 called Irrational Exuberance. It’s broader. I call it an adventure in consilience. There’s a chapter on that. Consilience is the unity of knowledge. I’m thinking that the perceptions of the economy either take into account information from a number of fields.
Irrational Exuberance was prescient in terms of predicting two bubbles. What bubbles do you see now, that narrative economics might affect?
Well, the bond market has been especially salient these past few days. The yields have gotten very low. And so that could burst. They’ve [interest rates] been going down since 1981, but there is a zero lower bound, maybe go a little bit below zero.
Cryptocurrencies might be another bubble, I suggest that. Maybe they’ll find Satoshi Nakamoto and he won’t be an impressive guy at all. Or maybe he will be, I don’t know.
Given your research, what are the most important factors shaping narratives that drive change or markets?
Well, this is a question for the people in the literature department. But what comes to my mind is a visual image, like in the case of the Laffer Curve, of a man writing in on a napkin, I don’t know why it’s so powerful an image. Or the visual image of George Washington chopping down a cherry tree. Why that is such a famous narrative? I’ll never understand except it has a visual of a little boy chopping down a tree. And other things are celebrity attachment, you can take an old narrative and attach a celebrity to it, and it becomes more viral. I mentioned the example of Williams Jennings Bryan. But there are other examples in the book. Well, Karl Marx is often quoted as saying “For each according to his abilities, to each according to his needs,” but in fact he was quoting Louis Blanc, a philosopher already famous for that quote. But Blanc got shoved aside as he wasn’t famous enough. Also, Louis Blanc was not an impressive looking man, he looked like a little man.
Karl Marx was [more impressive looking.] According to historians, Karl Marx received a gift of a bust of Zeus. So Karl Marx was a little bit famous. He had a beard. A friend of his said, “you know, you look like Zeus” the Greek god, the king of the gods and he gave him the bust of Zeus. And said look at that, isn’t that you? And the story is that Marx was thinking, I do look like the king of the gods. He’s a big, tough man. And he grew his beard out even bigger. So it was really an obnoxious beard. And that visual image still lives today.