These economic theories are based on evidence of a different kind than the observations embodied in time series: knowledge of the motives and habits of consumers and of the profit-making objectives of business enterprise, based partly on introspection, partly on interview or on inferences from observed actions of individuals—briefly, a more or less systematized knowledge of man’s behavior and its motives.7
In short, as Koopmans pointed out, traditional economic approaches fail to examine the role of public beliefs in major economic events—that is, narrative. By incorporating an understanding of popular narratives into their explanations of economic events, economists will become more sensitive to such influences when they forecast the future. In doing so, they will give policymakers better tools for anticipating and dealing with these developments. Indeed, my argument in this book is that economists can best advance their science by developing and incorporating into it the art of narrative economics. The following chapters lay the groundwork for bringing science and art together in a more robust economics.
The Moral Imperative of Anticipating Economic Events
Ultimately, the objective of forecasting is to intervene now to change future outcomes for society’s benefit. In his 1969 presidential address to the American Economic Association, Kenneth E. Boulding (another teacher who influenced me at the University of Michigan) said that economics should be considered a “moral” science, in that it is concerned with human thought and ideals. He inveighed against:
a doctrine that might be called the Immaculate Conception of the Indifference Curve, that is, that tastes are simply given, and that we cannot inquire into the process by which they are formed. This doctrine is literally “for the birds,” whose tastes are largely created for them by their genetic structures, and can therefore be treated as a constant in the dynamics of bird societies.8
Economics, Boulding says, “creates the world it is investigating.”9 Often, we don’t want to forecast but to warn. We don’t ever want to forecast a disaster; we want to take actions that will prevent the disaster from happening.
Newspaper accounts of central bank actions, such as the routine raising or lowering of interest rates, seem to reflect the assumption that the exact amount and timing of these actions are of central importance, rather than the words and stories that accompany them. Irving Kristol, writing in 1977, expresses the typical economist’s view succinctly, dismissing public opinion polls purporting to measure business confidence:
It is all supremely silly. Business confidence—as represented by the willingness to invest in new plant and equipment—is not a psychological phenomenon but an economic one. It is what Mr. Carter and what Mr. Burns do that counts, not what they say. John Maynard Keynes may have believed—and some of his disciples obviously still believe—that the propensity to invest is governed by the high or low “animal spirits” that prevail among businessmen. But then, Keynesian economists have always had a poor opinion of the intelligence of businessmen, whom they represent as temperamental children, to be paternalistically “managed.” … What governs business confidence are the prospects for profitable investment. That and nothing else—not what the president says, not what executives say, not what anyone else says.10
Kristol does not identify the economic forces that operate independently of stories to produce economic crises. He does, however, hint at the politicization of economics when he argues that economists insult businessmen’s intelligence when they try to describe less-than-optimizing business behavior. Many economists have learned that it pays to flatter businesspeople, whose support is useful to economists’ careers. Describing the economy as driven only by abstract economic forces suggests that the economy operates in a moral vacuum, that there is no criticism of their leadership.
John Maynard Keynes: Narrative Economist
Kristol’s dismissal of opinion polls notwithstanding, some of the most famous economic forecasts in world history appear to be based substantially on observations of narratives and worries about their human consequences. In his 1919 book Economic Consequences of the Peace, Cambridge economist John Maynard Keynes predicted that Germany would become deeply embittered by the heavy reparations imposed by the Versailles treaty ending World War I. Keynes was not the only person to make such a prediction at the end of the war; for example, the pacifist Jane Addams led a campaign for compassion for the defeated Germans.11 But Keynes tied his argument to evidence about economic reality. Germany was indeed unable to pay the reparations, and he was correct about the dangers of forcing Germany to try. Keynes predicted how Germans would likely interpret the reparations and the associated clause in the treaty asserting that Germany was guilty of war crimes. Keynes’s insight exemplifies narrative economics because it focuses on how people would interpret the story of the Versailles treaty given their economic conditions. It was also a forecast because he warned, amidst a “cheap melodrama” of foreign policy in 1919, about a war to come:
If we aim deliberately at the impoverishment of Central Europe, vengeance, I dare predict, will not limp. Nothing can then delay for very long that final civil war between the forces of reaction and the despairing convulsions of revolution, before which the horrors of the late German war will fade into nothing, and which will destroy, whoever is victor, the civilization and the progress of our generation.12
Keynes was right: World War II began amidst lingering anger twenty years later and cost sixty-two million lives. His warning was grounded in economics and tied to a sense of economic proportion. But Keynes was not talking about pure economics as we understand it today. His words “vengeance” and “despairing convulsions of revolution” suggest narratives filled with moral underpinnings, reaching to the deeper meaning of our activities.
From Irrational Exuberance to Narrative Economics
This book is the capstone of a train of thought that I have been developing over much of my life. It draws on work that I and my colleagues, notably George Akerlof, have done over decades,13 culminating in my presidential address, “Narrative Economics,” before the American Economic Association in 2017 and my Marshall Lectures at Cambridge University in 2018. This book makes a broad attempt at synthesizing the ideas in all these works, linking these ideas to epidemiology (the branch of science concerned with the spread of diseases) and putting forth the notion that thought viruses are responsible for many of the changes we observe in economic activities. The “story” of our times, and of our personal lives, is constantly changing, thereby changing how we behave.
The insights into narrative economics presented in this book dovetail with recent advances in information technology and social media because these are the conduits through which stories travel the globe and go viral in milliseconds, and which have had profound effects on economic behavior. However, this book also examines a long span of history in which communications were slower, when stories were repeated via telephone and telegraph and via newspapers delivered by truck or train.
This book is divided into four parts. Part I introduces basic concepts, drawing from research in fields as diverse as medicine and history, and offering two examples of narratives that many readers will recognize: (1) the Bitcoin narrative, whose epidemic began in 2009, and (2) the Laffer curve narrative, which went viral mostly in the 1970s and 1980s. Part II provides a list of propositions to help guide our thinking about economic narratives and to help prevent errors in such thinking. For example, many people do not realize that perennial narratives may undergo a process of mutation that renews once-strong stories and makes them strong again. Part III examines nine perennial narratives that have proved their ability to influence important economic decisions, such as narratives about others’ confidence or about frugality or job insecurity. Part IV looks to the future, with some thoughts about where narratives are taking us at this point in history and what kind of future research could improve our understanding of them. Following part IV is an appendix that relates the analysis of narratives to the medical theory of disea
se epidemics.
Acknowledgments
My 2017 American Economic Association (AEA) presidential address, “Narrative Economics,” was published in the April 2017 issue of the association’s journal, the American Economic Review. Many passages from that presidential address have found their way, often with modifications, into this book.
This book is strongly influenced by two books I wrote with George Akerlof, Animal Spirits (2009) and Phishing for Phools (2015). Another strong influence is the book George Akerlof wrote with Rachel Kranton, Identity Economics (2011). Narratives play a role in all these books. Working with George aided my thinking immeasurably.
The research that underlies this book has taken place over decades. I acknowledge research support over the years from the US National Science Foundation, the Cowles Foundation for Research in Economics at Yale University, the Smith Richardson Foundation, the Whitebox Foundation via the Yale School of Management, and the James Tobin research fellowships at Yale.
I thank participants in seminars at which I presented earlier versions of my AEA address, notably as the Marshall Lectures at Cambridge University and as seminars at the Bank of England, at the Toulouse School of Economics/Toulouse Institute for Advanced Study, and at the Yale University Department of Economics. Special thanks go to Bruce Ackerman, Santosh Anagol, Bob Bettendorf, Bruno Biais, Laurence Black, Jean-François Bonnefon, Michael Bordo, Stanley Cohen, Donald Cox, Robert Dimand, William Goetzmann, Emily Gordon, David Hirshleifer, Farouk Jivraj, Dasol Kim, Rachel Kranton, Arunas Krotkus, Naomi Lamoreaux, Terry Loebs, Ramsay MacMullen, Peter Rousseau, Paul Seabright, John Shiller, Thomas Siefert, and Sheridan Titman.
Peter Dougherty, who stepped down in 2017 as director of Princeton University Press and is now editor at large, has been a formative influence on me for twenty years. He has always encouraged me to stay on a true path in my writing, a contribution that has been invaluable to me. He is now, after leaving the helm of the Press, still giving me editorial help.
Research assistance was provided by Logan Bender, Andrew Brod, Laurie Cameron Craighead, Jaeden Graham, Jinshan Han, Lewis Ho, Jakub Madej, Amelie Rueppel, Nicholas Werle, Lihua Xiao, and Michael Zanger-Tishler. I am also indebted to other Yale students who made comments or suggestions: Brendan Costello, Francesco Filippucci, Kelly Goodman, Patrick Greenfield, Krishna Ramesh, Preeti Srinivasan, and Garence Staraci.
My indefatigable administrative assistant at Yale, Bonnie Blake, read and edited the manuscript. Much appreciation, too, needs to be acknowledged for my very thorough and detail-oriented copyeditor, Steven Rigolosi.
Some of the ideas in this book have come from my experience with writing more than two hundred newspaper columns, the equivalent of two books by word count. Since 2003, I have been regularly contributing columns to Project Syndicate; these columns are published in newspapers around the world, mostly outside the United States. Writing for Project Syndicate has helped me develop a world perspective and avoid an excessively US-centric view. Since 2007, I have also been a contributing columnist for the Sunday Business section of the New York Times. I thank my editors at these outlets, Andrzej Rapaczynski (Project Syndicate) and Jeff Sommer (New York Times), who have given me much attention.
Finally, I thank my wife of forty-three years, Virginia Shiller, for her continuing support and encouragement of my work.
Part I
The Beginnings of Narrative Economics
Chapter 1
The Bitcoin Narratives
This book offers the beginnings of a new theory of economic change that introduces an important new element to the usual list of economic factors driving the economy: contagious popular stories that spread through word of mouth, the news media, and social media. Popular thinking often drives decisions that ultimately affect decisions, such as how and where to invest, how much to spend or save, and whether to go to college or take a certain job. Narrative economics, the study of the viral spread of popular narratives that affect economic behavior, can improve our ability to anticipate and prepare for economic events. It can also help us structure economic institutions and policy.
To get a feel for where we are going, let’s begin by considering one such popular narrative, recently in full swing. Bitcoin, the first of thousands of privately issued cryptocurrencies—including Litecoin, Ripple, Ethereum, and Libra—has generated enormous levels of talk, enthusiasm, and entrepreneurial activity. These narratives surrounding Bitcoin, the most remarkable cryptocurrency in history as judged by the speculative enthusiasm for it and its market price rather than its actual use in commerce, provide an intuitive basis for discussing the basic epidemiology of narrative economics (which we explore in detail in chapter 3).
An economic narrative is a contagious story that has the potential to change how people make economic decisions, such as the decision to hire a worker or to wait for better times, to stick one’s neck out or to be cautious in business, to launch a business venture, or to invest in a volatile speculative asset. Economic narratives are usually not the most prominent narratives circulating, and to identify them we have to look at their potential to change economic behavior. The Bitcoin story is an example of a successful economic narrative because it has been highly contagious and has resulted in substantial economic changes over much of the world. Not only has it brought forth real entrepreneurial zeal; it also stimulated business confidence, at least for a time.
Of Bitcoin and Bubbles
The Bitcoin narrative involves stories about inspired cosmopolitan young people, contrasting with uninspired bureaucrats; a story of riches, inequality, advanced information technology, and involving mysterious impenetrable jargon. The Bitcoin epidemic has progressed as a cascading sequence of surprises for most people. Bitcoin surprised when it was first announced, and then it surprised again and again as the world’s attention continued to grow by leaps and bounds. At one point, the total value of Bitcoin exceeded US $300 billion. But Bitcoin has no value unless people think it has value, as its proponents readily admit. How did Bitcoin’s value go from $0 to $300 billion in just a few years?
The beginnings of Bitcoin date to 2008, when a paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System,” signed by Satoshi Nakamoto, was distributed to a mailing list. In 2009, the first cryptocurrency, called Bitcoin, was launched based on ideas in that paper. Cryptocurrencies are computer-managed public ledger entries that can function as money, so long as people value these entries as money and use them for purchases and sales. There is an impressive mathematical theory underlying cryptocurrencies, but the theory does not identify what might cause people to value them or to believe that other people will also think they have value.
Often, detractors describe the valuation of Bitcoin as nothing more than a speculative bubble. Legendary investor Warren Buffett said, “It’s a gambling device.”1 Critics find its story similar to the famous tulip mania narrative in the Netherlands in the 1630s, when speculators drove up the price of tulip bulbs to such heights that one bulb was worth about as much as a house. That is, Bitcoins have value today because of public excitement. For Bitcoin to achieve its spectacular success, people had to become excited enough by the Bitcoin phenomenon to take action to seek out unusual exchanges to buy them.
For Bitcoin’s advocates, labeling Bitcoin as a speculative bubble is the ultimate insult. Bitcoin’s supporters often point out that public support for Bitcoin is not fundamentally different from public support for many other things. For example, gold has held tremendous value in the public mind for thousands of years, but the public could just as well have accorded it little value if people had started using something else for money. People value gold primarily because they perceive that other people value gold. In addition, Peter Garber, in his book Famous First Bubbles (2000), points out that bubbles can last a long time. Long after the seventeenth-century tulip mania, rare and beautiful tulips continued to be highly valued, though not to such extremes. To some extent, tulip mania continues even today, in a
diminished form. The same might happen to Bitcoin.
Nonetheless, the value of Bitcoin is very unstable. At one point, according to a headline in the Wall Street Journal, the US dollar price of Bitcoin rose 40% in forty hours2 on no clear news. Such volatility is evidence of the epidemic quality of economic narratives that may lead to an erratic jostling of prices.
I will make no attempt here to explain the technology of Bitcoin, except to note that it is the result of decades of research. Few people who trade Bitcoins understand this technology. When I encounter Bitcoin enthusiasts, I often ask them to explain some of its underlying concepts and theories, such as the Merkle tree or the Elliptic Curve Digital Signature Algorithm, or to describe Bitcoin as an equilibrium of a congestion-queuing game with limited throughput.3 Typically the response is a blank stare. So, at the very least, the theory is not central to the narrative, except for the basic understanding that some very smart mathematicians or computer scientists came up with the idea.
Narrative economics often reveals surprising associations. Reaching back into history, we see the beginnings of the emotions behind the Bitcoin epidemic in the origins of the growth of anarchism in the nineteenth century.
Bitcoin and Anarchism
The anarchist movement, which opposes any government at all, began around 1880 and followed a slow growth path, according to a search for anarchist or anarchism on Google Ngrams. But the term itself dates back decades earlier, to the work of philosopher Pierre-Joseph Proudhon and others. Proudhon described anarchism in 1840 as follows:
To be GOVERNED is to be watched, inspected, spied upon, directed, law-driven, numbered, regulated, enrolled, indoctrinated, preached at, controlled, checked, estimated, valued, censured, commanded, by creatures who have neither the right nor the wisdom nor the virtue to do so.4
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