Robert Shiller:  Behavioral economics usually tries to look at established human traits to explain why people make mistakes. Narrative economics looks at how people change opinions that affect their actions and how these spread from one person to another.

TA:  Just what is an economic narrative?

RS:  Typically, it's an illustrative story, often involving celebrities. The stories are frequently patriotic and sometimes heighten a sense of injustice, or make people angry or make them laugh. They have to be contagious [go viral]—spread by newspapers, magazines, TV, social media—to succeed as narratives.

TA:  Does the celebrity component make a narrative more contagious?

RS:  Yes—and more dramatic. In his 1933 inaugural address, Franklin D. Roosevelt said, "The only thing we have to fear is fear itself," which was an interpretation of the Great Depression. But he wasn't the first to say that. One of the others was the assistant to the mayor of Boston, who nobody had ever heard of. So the guys that said it before Roosevelt didn't cut it. But when he said it before a crowd of hundreds of thousands, it was a story that people remember to this day.

TA:  Do narratives have to be true?

RS:  No. It may help [contagion] if they aren't because rarely do people check the facts. They just repeat what they've heard. [However], narratives can be true. They can point out facts that haven't been paid attention to, and that can affect people's judgment.

TA:  For example?

RS:  The Great Depression was a narrative that exploded during the financial crisis [2008–2009]. People already knew that narrative, but it became contagious again when it seemed that maybe [another deep depression] was happening, which caused them to curtail their spending.

TA:  What's a modern narrative that's gone viral?

RS:  The Trump narrative, which has really taken over. He developed and perfected this narrative over half a century. It is: The ideal man isn't afraid to show off. He's adorable to women. This impresses a lot of men who like to imitate men that are followed by a trail of beautiful women. Trump developed this narrative, including the story that he isn't politically correct—that he would speak the truth—and that everything you heard out of Washington was a pack of lies.

TA:  What are the implications of his narrative?

RS:  One thing it seems to mean is that you don't have to worry about modesty. So people are willing to spend money extravagantly and feel like they have to because Trump's attitude toward losers is dismissive—they're worthless.

TA:  Regarding the impeachment inquiry, Trump insists he's done nothing wrong and that he thinks he has the right to do whatever he wishes in executing the office of president. Is this a narrative?

RS:  It's part of a constellation of narratives. People just seem to relish telling stories about Trump. It's probably his audacity, but he has an instinct of what is a tellable story. He knows that being a self-made billionaire is very central to his story. That's why he doesn't want to release his tax returns—it might raise questions about whether he really is a self-made billionaire.

TA:  What's another Trump narrative?

RS:  If you try to discuss some details of government regulation, that would be boring, and people just wouldn't care. But if you talk about wanting to kill two regulations for every new regulation, that's the Trump narrative. It's more tellable.

TA:  Can narratives help economists in their forecasting?

RS:  I think they've helped me. I wrote "Irrational Exuberance" in 2000 because I thought the narratives of the time were extravagant, when the stock market was at its highest level ever relative to long-term earnings. For the second edition of my book, which came out in 2005, because I was listening to real estate narratives, I added data that I collected on U.S. home prices going all the way back to 1890. The [narratives] were a foreshadowing of the financial crisis because it seemed that everybody—both homebuyers and lenders—believed that home prices would [keep going] up.

TA:  You argue that narratives' contagion needs to be incorporated into economic theory. Why?

RS:  Policymakers have to make judgments about narratives because often the impact of their decisions depends on these stories. The strength and radical-ness of their decisions are informed by their ideas of how dangerous a situation is. It would help if evidence were presented about narratives.

TA:  Some narratives may actually generate very little talk, you point out. Such as?

RS:  They can be in the background, like this human interest story: Influenza in the U.S. is dormant right now, but you should get your flu shot because the flu is coming, and there are forecasts it will be a bad flu season. Australia had a severe flu epidemic this summer [when it was winter there]. In this [narrative] Australia is a leading indicator for the U.S.

TA:  The latest wave of consumer technology-based fears began around 2016 and continues unabated, you write. You cite the current narrative of people fearing that machine learning and artificial intelligence will replace human intelligence. Please elaborate.

RS:  I was amazed how far back I could [find] stories about this. It went all the way to Homer's "Iliad," written in 700 B.C. He talks about a self-driving vehicle. In 1920 there was a play, "R.U.R." ["Rossum's Universal Robots"] about robots taking over the world and killing us. That idea stuck with us: These things seem to be our friends, but they might be our enemies. It's a perennial narrative. Now that we have voice recognition and voice actuation, the emphasis is that [robots will] replace human intelligence. That your job might be replaced by a machine is scary for practically anyone. The question is: Why isn't it scaring the consumer more right now?

TA:  Why do you think?

RS:  I don't have an explanation why consumer demand has held up so well in the U.S. while other advanced countries seem to be falling into recession. Economists are too afraid of interpreting people's motives, so they rely on the assumption that they're logical, rational, and consistent—which is OK for some uses, but it's not perfect. Not many people forecasted the Great Recession because maybe they were thinking too abstractly and weren't watching what [consumers] were saying.

TA:  Can narratives be applied when making investment decisions?

RS:  Rather than using narratives directly, they're more for understanding why, for example, sometimes assets are overvalued and other times, they're undervalued. But one can look at investments and decide they're being supported by narratives rather than sound prospects. Narrative economics seems to require human judgment to implement. Are the stories sound? Where do they come from? [That is], you might want to stay away from some of these investments.

TA:  There's a famous story about a shoeshiner's giving stock tips to a prominent investor. Most people know that narrative because it's been highly contagious. Your thoughts? 

RS:  That narrative involves [one of these]: John D. Rockefeller, Joseph Kennedy Sr., or [financier] Bernard Baruch. One of them, on the advice of the shoeshine boy, sold stock before the 1929 peak and made [a great deal of money] in the crash. I traced this narrative to about 1911, when it wasn't about a shoeshine boy. But it was the same idea: Someone in a lowly profession was giving stock tips, and that was a sign to get out.

TA:  You write that former Federal Reserve chair Alan Greenspan's statement about seeing "a little froth" in the housing market "contributed to a constellation of narratives, among them, those with the power to change the economic behavior and bring on a financial crisis." Please elaborate.

RS:  [In 2005], Alan Greenspan said there was no [real estate] bubble—that there was nothing more than a little "froth" in the [housing market]. He was minimizing concerns about the boom in home pricing. Then [Ben] Bernanke [Greenspan's successor] came in. He initially minimized the situation, too, until he finally had to deal with it.

TA:  You write about a vintage narrative epidemic that's still growing today—the one about "the American dream." Please comment.

RS:  It dates back to the Depression. Then Martin Luther King, Jr.'s "I Have a Dream" speech [of 1963] propelled it. When he was tragically assassinated, that narrative became a legend. The other thing that propelled this narrative was advertisements by realtors who were offering the American Dream house. So it tilted a little toward real estate. But when James Truslow Adams coined the phrase, the American dream, in his book, "The Epic of America" [1931], he didn't mention housing. He talked about motorcars.

TA:  So the American Dream narrative became ingrained in American culture. But how did it manifest?

RS:  The American dream says that anyone can have it if they try hard: This is the land of opportunity, so my living in a big house and having two fancy-looking cars is an inspiration to other people that they can do it, too, if they try hard. The American Dream narrative may be related to entrepreneurship, too: "I'm going to start a new company, and it will be fabulous."

TA:  Incidentally, what's in your investment portfolio?

RS:  I try to diversify around the world. I'm lightening up on stocks. I own my own products [Shiller Barclays indexes]. I've never invested in bitcoin, but I don't rule it out. I can see it in small amounts but not dominating your portfolio.

From: ThinkAdvisor