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Robert Shiller on the Power of Narrative Economics

Many academically-minded economists worked to establish a mathematical basis and modeling in the study of economics in the 20th century. But this approach has not always produced reliable results. Financial Sense Insider spoke with nobel prize-winning economist Robert Shiller on the podcast. He discusses his new book Narrative Economics: How Stories Go Viral and Drive Major Economic Events. Shiller also explains how he sees the power of narrative shaping human economic behavior.

See Robert Shiller on Narrative Economics: How Stories Go Viral and Drive Major Economic Events for audio.

Stories Drive Economics

Economists are asked to make predictions about what is going to happen. Traditionally, they might cover issues such as the exhaustion of natural resources, technological progress, a new act of Congress, or the actions of the Federal Reserve.

However, the study of economics is changing, Shiller stated. The problem with giving these events or actions an explanatory purpose, is that it ignores the narrative behind the event or action that is driving the behavior.

“A very important source of economic change is in people's thinking about how the economy works, and what it should be doing,” Shiller said. “Average people are not economic theorists. They convey these ideas to each other through narratives, stories with a moral or an interpretation of events. I think economists need to study those stories if they're going to really be able to forecast well.”

Rational Actor or Storyteller?

In economics, the central conceit has long been that humans are rational economic actors, making decisions in their best interest using their reason to determine their desires.

Classifying humans based on intelligence is one approach, Shiller stated, but we have other shared traits that may be more important when it comes to study economics. The scholarly approach has its place, Shiller stated, but most humans are not steeped in the economics tradition. Rather, they think in terms of stories.

“A universal truth about humans is that everywhere, in every human society, we use language and tell stories,” Shiller said. “I'm a big admirer of traditional economics, but I think we have to keep moving ahead. There was a fad among economists to rely on mathematics. … It's interesting, but it's not all we need. The second half of the 20th century in economics involved ignoring psychology, sociology, anthropology and history. That was a useful phase, but it's time to move on.”

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Viral Stories

The field of economics may do well to take a cue from the study of epidemiology. If narrative structures and story-telling inform how people make economic decisions, the spread of a story from person to person mimics the spread of infection, in many respects.

For example, the phrase ‘going viral,’ is tossed around a lot, Shiller noted. No one knows exactly why this happens, but it likely has to do with a compelling story creating a chain reaction in people. Because of the ubiquity of the internet and social media, that narrative can spread rapidly.

It this way, a story is like a virus, and how compelling it is may be akin to how communicable a virus is. In the case of viral narratives—just as in simple epidemic models—something affects the contagion rate.

It could be that a critical mass of tellers is reached, or a narrative addresses a certain psychological issue or concern at the time, but some trigger or triggers creates an explosion of interest in the story. Whatever the trigger, the explosion in interest overcomes the rate at which people are forgetting about the story, and it spreads.

“Storytelling displays the same dynamic as disease,” Shiller said. “They’re just as mysterious. How did this happen? Or how does this politician suddenly appear and become so prominent? It's because of contagion of stories.”

Self-fulfilling Prophecies

It isn’t always easy to determine if a narrative is driving a behavior, or the behavior is driving the narrative. Because of this, it can be difficult to identify narratives and the impact they will have in real time.

Take, for example, the explosion in the interest surrounding flipping houses. Stories of “house flippers” garnered everyone’s attention. The term didn’t really exist before the early 2000s, Shiller noted, but the narrative caught on that this was an easy way to make money.

Eventually, the narrative flipped, and the notion that house flipping was foolish and would lead to loses became prominent. At some point, the phrase “housing bubble” became popular. While some economists think of these events as being driven by Fed actions or some other cause, Shiller stated, the reality is they are driven by a common narrative.

This pattern plays out in history, as well. The idea that fear of automation is a modern phenomenon is wrong, Shiller stated, and the narrative that humans would be replaced by machines is ancient.

“It's important to understand that narratives sometimes spread very fast, even thousands of years ago,” Shiller said. “Narratives have had similar effects throughout history. They have a potential for contagion, if conditions change or if there's some mutation in the narrative. … When the first newspapers were invented in the early 1600s, we had the Tulip Mania. … Eventually, a narrative gets tired, and people start laughing at the narrative. The problem is, it's not obvious how to start a new narrative and make it work to stimulate the economy.”

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