Do We Talk Ourselves into Bubbles and Recessions?

Professor Robert J. Shiller speaking at the World Bank Nov. 16, 2010. (c) 2010. Used with permission.

​An interview with Nobel Prize winning economist Robert Shiller, who is the author of the new book Narrative Economics and the iconic book Irrational Exuberance. Shiller discusses how the stories we tell one another drive the economies of the world – sometimes into bubbles, sometimes into tearing down walls (like the Berlin Wall in 1989), and other times into depressions.
 

On September 25, 2019, Professor Shiller and I spoke about his new book, Narrative Economics, and what some of the stories that are currently in circulation say about where the economy is headed. Is a recession, or a continued rally, on the horizon? Below is a transcript of our conversation.  
 
 
Natalie Pace: How can the study of stories help the economic profession to better forecast events, and perhaps even mitigate their severity?
 
Professor Robert J. Shiller: The economics profession has had some success in forecasting economic events. But there has been a tendency to miss some of the most important factors, which are changes in the way people are thinking, that they get from each other through a kind-of contagion. The problem is that human conversation hasn’t in the past been largely recorded and available for searching. It’s getting a lot better. We can start to see what people are thinking, and how it’s changing. This will bring a revolution in economics.
 
NP: As you noted in Narrative Economics, the frugality consciousness after the Great Depression may have contributed to the very rough decade that folks experienced in that era. Is there any mindset that is going on now that you believe we should be observing and discussing more?
 
RJS: There are some that are obvious: Donald J. Trump and other populists like him, in other countries. Everyone is talking about it. I can’t add to it in any significant way, other than to say that it has really dominated our talk. It comes up with such regularity, and it’s polarizing. There are other narratives that are not thought of as narratives. One of them is the artificial intelligence narrative – stories about particular inventors and machines that will replace human intellect. That’s one that is lying in wait to affect our confidence. It’s definitely there, but I can’t claim that it has reduced our GDP yet.
 
NP: I just saw an ad for Super Store where one of the employees screams that robots are coming to take our jobs. Does this fear act like a deer in the headlights for our psyche, stopping our confidence in our ability to earn income, which puts the brakes on our purchases, which knocks down GDP?
 
RJS: That’s how it happened in the past. In the Great Depression, there was a lot of talk of robots replacing jobs. It’s not part of our conventional history of the Great Depression. The word robot was invented in 1920. In the Great Depression, when people saw unemployment going up, they blamed it on robots. They didn’t have robots that walked around and talked, but they had plenty of machines. It could happen again because artificial intelligence is such a stunning development, with things like driverless cars and pilotless ships. Artificial intelligence looks like it’s going to have an impact on our jobs.
 
NP: In the wake of the Great Recession, did credit return more quickly to the consumer than it did in the Great Depression? How much of the recovery that we’ve seen was just access to money? Many of our banks and insurance companies wouldn’t even be in existence if we hadn’t bailed them out. Obama famously told bankers that he was all that stood between them and the pitchforks.
 
RJS: Our credit markets have developed a lot since the Great Depression, and they are regulated better. In the early years of the Great Depression, there was no Securities and Exchange Commission. There was no Financial Stability Board. There was no Consumer Financial Protection Bureau. We learned, and things are better. We still are vulnerable to a consumption pullback, even though interest rates are low. People can afford to consume more because the cost of borrowing to do that is lower. Right now, consumption demand is holding up in the U.S. That could change though.
 
NP: Credit card debt and consumer debt is higher than it has ever been. Businesses can still borrow at very low rates. However, I hear from small business owners who borrow on their credit cards to float their commerce. Those rates are exorbitant – usury rates.
 
RJS: You don’t hear that word usury so much these days. There have been variations in people’s willingness to borrow. It’s not just due to the interest rate. It’s because of a story of prudent living – a narrative again.
 
NP: Corporate buybacks have really driven this bull market. Main Street has been rather skeptical, up until 2016. What are your thoughts on the stories being told today about stocks?
 
RJS: One thing that is happening is that there is a shading of the worry about crash. The lowest ebb for safety in the market was right at 2009. Although the market had gone down 50% in real terms, people thought it would go down even further. They were talking about 1929 in exorbitant levels. Now that narrative is fading. However, we still call that recession the Great Recession, which is a play on the words Great Depression, so it’s still on our minds. The recovery that we’ve seen since then is partly due to just forgetting about the stories that we heard about people losing their houses and suffering under unemployment. They are not fresh in our memory anymore. It may be that more than any new narrative.
 
It’s also the Donald Trump narrative, which provides a script for a new way of living – more ostentatious. You may feel more embarrassed about being poor. Trump talks about losers. He’s very harsh in his judgment of some people. That affects our thinking. We have to keep up with the Joneses. They used to say that in the Depression, but they said it pejoratively.
 
NP: The shift toward nationalism that began with the new Administration is not just in the U.S. There are a lot of countries grappling with this. You noted that this mindset was viral before World War II.
 
RJS: I’m worried about the polarization in our societies and the rise of primitive nationalism. Part of my theory is about stories going viral. But it is also about stories that are forgotten. One of the powerful narratives that is being forgotten is World War II. That was such a nightmare. For a long time afterwards, people were much kinder to one another and supportive. That’s fading. We’re slipping back into our tribal past, and it’s worrisome.
 
NP: What are the impacts historically of trade wars? Are tariffs an effective tool to stoke economies, or is it the exact opposite?
 
RJS: Ever since Adam Smith, who wrote The Wealth of Nations in 1776, economists have a visceral negative reaction to tariffs. They think it is just protecting less competent businesses. It happens because of bribery of one sort or another. A lot of people during the Great Depression believed that the Trade War, created by the Smoot-Hawley Tariff Act in 1930, was the cause of the depression. It didn’t work. The economy just sank into the worst depression ever experienced by 1933. It’s an old narrative that is recovering today, and it may have an even worse impact on our economy.
 
NP: Part of the trade war sloganeering to the populace is to protect jobs and bring manufacturing back.
 
RJS: We do have a problem of rising inequality. A couple of our Democratic candidates seem to be addressing it. However, it may be a better election strategy to focus on immigrants as a threat to our jobs. However, this is potentially damaging to the economy.
 
NP: So, the Great Depression experienced a toxic cocktail of frugality, nationalism and tariffs? Were there other contributing factors that we need to be looking at today as well.
 
RJS: One important factor in the Great Depression was that people were thinking more about confidence and the confidence of others. It was a general trend early in the 20th century that people were reading more about psychology. They thought depression referred to a mental state, but it also occurred in the economy. Now we have these confidence numbers talked about all the time. We have the stock market reported every day, as if that was a measure of confidence in the economy. Actually, it is a measure of confidence in something more narrow than the whole economy. However, we’re accustomed to thinking of that as a barometer of our national psyche.
 
NP: The White House has been very vocal about zero interest rates. The Federal Reserve had 3 dissents in the last meeting, when they lowered interest rates. There is a very wide-ranging view of what the policy should be. The market is expecting another cut in December. What are the problems with pervasively low and zero interest rates?
 
RJS: It’s a complicated decision. That’s why there is dissent at the Federal Open Market Committee. Part of the reason that it is ambiguous is that it involves human psychology and human narratives. The idea of cutting interest rates all the way to zero as a dramatic stimulus measure… I’m more than a little uncomfortable with that because it’s like your doctor giving you a strong anti-depressant for your mental condition. You think, “I must be really mentally ill if he gave me that.” It harms your psyche. It reminds them of the famous narrative of the Lost Decade in Japan, which is really decades, after they cut interest rates to zero. It didn’t work for Japan either.
 
NP: Are you concerned about asset bubbles and financial instability? More than 50% of the corporate bonds are just a hair above speculative, and Ford was just downgraded to junk by Moody’s.
 
RJS: Yes, I am concerned because there is a debt/liquidity cycle and a leverage cycle. We’re seeing corporate balance sheets being leveraged. I don’t like to use the words leading indicators loosely, but it has been a sign of approaching recession. There is also a question of how big and how strong. We will have a recession eventually. I don’t know if it will be in 2020. But if memories of the 2008-2009 financial crisis come back, that could harm confidence.
 
NP: You’re saying that just the narrative itself could actually create a deeper recession than needs to be…
 
RJS: That’s the idea that I’m promoting in my book Narrative Economics, that stories are causal elements. Narratives are like diseases, like influenza. Influenza lies relatively tame until suddenly there is a big epidemic. Or maybe it’s not so big. It depends upon mutations in the influenza virus and maybe something like weather conditions. The same thing is true with narratives. The artificial intelligence narrative doesn’t seem to be scaring people, but it’s there. It could come back into a big scare.
 
NP: You point out that stories can evolve just like viruses. In the Dot Com Recession, the artificial intelligence narrative was not a scare, but something that everyone wanted to profit from.
 
RJS: That’s right. And then the Dot Com thing came to an end right around the time that Barron’s published an article called “Burning Up,” which documented how many of those Dot Com companies were close to insolvency. It became a sudden narrative that: “This is it.” [The Dot Com Recession] also came after the New Millennium. We heard all of these expansive stories about the future, and here we are in 2000, and it’s looking kind of iffy. Maybe we were suffering a hangover after our New Millennium party.
 
NP: What do you think about the Sharing Economy and Micro Mobility, which are hallmarks of Millennials and Gen Z. Is this a new modesty craze that might spark frugality?  
 
RJS: The bike craze happened before. During the Great Depression, a lot of stores set up bike racks because there was a big switch to riding a bike. Right now, this isn’t associated with poverty, but it could become associated with that. Bikes are relatively cheap.
 
NP: Interesting. Cheap bikes and e-scooters, which are getting popular out of necessity, can play into the Donald Trump “I’m winning” narrative, without being seen as frugality…
 
RJS: The problem with narratives is that they are so subtle. You can’t just focus on a word. Ultimately it reflects humanity, and the deep complexity of our minds and our emotions. So, the idea is that some kind of new narrative just gets started. It goes like wildfire. It can stimulate demand, and it can contract demand. It’s not something that we can view at this point from a purely mathematical viewpoint. We have to look at the content of the story, and what is it that makes it so contagious.
 
NP: Let’s talk about the rescue last week of the overnight repo market, which popped from 2 to 10% interest.
 
RJS: Monetary experts view that as a glitch that will be handled by the Federal Reserve. The 10% interest rate was momentary. It disappeared quickly. It could get magnified. The question is, “How is the story received by the public?” For example, in October 19, 1987, we had the biggest stock market one-day drop ever. It was over 22% in the Dow in one day. There was talk of the Great Depression then, but it just didn’t register. There was no recession after that. People thought it was just some technical glitch. At another time, the story could take another dimension. It’s really hard to predict.
 
NP: Ronald Reagan was very good at slogans. Do you think there was some slogan that he pulled out that people just bought into?
 
RJS: I’m thinking it was a Reagan joke. He was great at jokes. The Reagan jokes were generally about the Soviet Union, and they were very effective.
 
NP: OK. Let’s hear one.
 
RJS: A man just bought a new car in the Soviet Union. The salesman is drawing up the final papers and he says, “Funny thing. I see that your car will be delivered on today’s date exactly ten years from now.” The buyer says, “Morning or afternoon?” The salesman responds, “It’s ten years from now. How can you care whether it is morning or afternoon?” The buyer says, “Well, the plumber is coming by in the morning.”
 
NP: Apparently those jokes were so effective they could tear down walls.
 
RJS: Those big changes in the Soviet Union were narrative induced. When I visited Moscow in 1989, I was struck at how people would talk against the government. I thought this was not allowed. Of course, you didn’t see this in the newspapers. I had a tour guide, an official tour guide, who showed me around the Kremlin. She said, “I think civil war is coming to Russia.” That was 1989, before the Internet and with no newspapers reporting on this.
 
NP: But there might have been some sort of economic recession that preceded that mind shift?
 
RJS: Yes. We went into a department store and they had nothing there. There were long lines. I asked someone what he was standing in line for and he said, “Soap.” Things weren’t working right. They sensed hypocrisy. They wanted a change.
 
NP: There’s an ancient Chinese saying that the Emporer stays in power as long as the economy is good. When an economy tanks, there is a divine authority and a change in leadership.
 
RJS: I hadn’t heard that.

NP: I remember it from a Chinese culture survey course at USC.
 
RJS: See, we remember the jokes and the narratives easily…
 
NP: The housing market appears strong. The unaffordability index is starting to look problematic. Do you see potential problems or warning signs here?
 
RJS: We have our own S&P CoreLogic Case-Shiller Home Price Indices. With our latest data, prices seem to still be going up, nationwide, in most places. However, it’s going up at a much lower rate. It used to be in double digits, shortly after the bottom of the market, in 2012. On the national index, it’s about 3% now, which is much lower. That is a sign of weakness. This market is different than the stock market. It has much more momentum to it. If we are losing momentum, it could have a drop-off like we saw in 2006, before the financial crisis.
 
Home prices are a lot higher than they were in 2012. You could easily imagine that we could see a drop. I’d hate to suggest that it will be anything as dramatic as what we saw 10 years ago. That was unusual. That was the most dramatic drop in real home prices that we’ve ever experienced.
 
NP: There are far fewer liar’s loans and extreme overleverage, like there was before the Great Recession.
 
RJS: We have regulation that discourages overleverage. Also, people are more careful now. There is still a fear of debt, oppressive debt. It’s an old narrative that goes way back to Thomas Jefferson – even before.
 
NP: Where does the CAPE ratio currently stand? What are the risks and indications of where stock prices are today?
 
RJS: The CAPE ratio is between 28 and 29, or there about. That is high by historical standards. The historical average is about 17. But it’s not as high as it has ever been. We had a price earnings ratio of 46 in the beginning of 2000. That is more than 50% higher than it is now. So, we could keep going up and not break any records. But it is a concern. I think the expected return on the stock market isn’t as good now.
 
NP: However, Main Street investors also have to be careful on the “safe” side, since there is so much leverage in the bond market…
 
RJS: If you’re thinking of pulling out of the stock market and going into the bond market, you’ve got a problem. The bond market has very low yields. So, it’s not clear what to do. Be careful about over-investing in the U.S. market. Consider investing in stock markets around the world to diversify. There’s no reason to panic right now that I see. We’ll find out.
 
NP: Do you have any last thoughts on the economy today?
 
RJS: The economics profession is changing with the times, and particularly with the availability of data. We have digitized texts with all sorts of human exchange, talk and conversation. It will take decades for the economics profession to sort this out. With modern computers, which will be an essential element of the research, we should be able to classify and organize our thinking about narratives. Narratives repeat themselves in history, but you have to have them up to date. There are so many narratives that it is hard to summarize the effect of all of them. I think we’ll get there.
 
NP: But there are some pervasive, over-riding themes to our stories, right?
 
RJS: That’s right and they can come back. There are enough people who remember [the old stories] that they provide a background from which to take off again. And the stories may have a human-interest component that is very strong. Any narrative around some people making a lot of money fast tends to be contagious. That’s why we have bubbles.  
 
There are also narratives that have a different emotion attached to them, not so much glory and making a lot of money, but it can also be anger at other people and the willingness to boycott something – some nation or some product.
 
NP: All of that played into cryptocurrency.
 
RJS: That’s right. It was an anarchist sentiment. The anarchist narrative goes back to the early 19th century. Hatred of government, in the sense that if government didn’t exist, we’d be fine. One of the reasons that cryptocurrencies have been so popular is that they seem to suggest a route toward a cutting off of government influence, that we cosmopolitans can run our business quite well, thank you. We don’t need the government regulating us.
 
On top of that, we had this nice mystery story about Satoshi Nakamoto who is the supposed inventor of Bitcoin. Nobody can find him. Nobody knows who he was. Maybe it was some committee that wrote the code. That actually adds to the narrative. People like mystery stories. Whenever someone comes forth claiming to be Satoshi Nakamoto, it’s like Anastasia or Delphine. When someone can’t be found and imposters keep coming up, that’s a great story.
 
NP: You’re not seeing doom and gloom on the horizon here. You say there might not even be a recession in 2020…
 
RJS: Right. There’s also a question of how bad a recession it will be when it does come. A lot of recessions have been mild. Let’s hope for the best.

​
 
Click to listen to my full interview with Professor Robert Shiller on BlogTalkRadio.com/NataliePace. Watch Professor Shiller talking about Narrative Economics in the video below. 

About Robert Shiller
Professor Robert Shiller is one of the leading economists of today. His work on inefficient markets earned him a Nobel Prize in economics in 2013. He is the author of many bestselling books, and is a frequent guest on television and at major economic conferences worldwide. Professor Shiller is the Sterling Professor of Economics at Yale University. 

​