Narrative Economics: How Stories Go Viral & Drive Major Economic Events
by Robert Shiller
Princeton University Press, 2019

The Nobel Prize-winning economist and Yale professor Robert Shiller has written a new book called Narrative Economics, in which he argues that “traditional economic approaches fail to examine the role of public beliefs in major economics events” and “that economists can advance their science by developing and incorporating into it the art of narrative economics”: 

economists long assumed that people are consistent optimizers of a sensible utility function using all available information with rational expectations. . .This theory omits some clearly important phenomena. Fortunately, the behavioral economics revolution of the last few decades has brought economic research closer to that of other social sciences. No longer do economists routinely assume that people always behave rationally.

Let’s contextualize this: In the late 19th century (rational) Economic Man, or homo economicus, came to us out of criticism of John Stuart Mill’s 1836 piece “On the Definition of Political Economy” which, as he admitted, provided “an arbitrary definition of man.” The rationality assumption is not so simple, and classical economists were not so crude, as modern characterizations would lead you to believe. It is true to say, however, that standard finance has developed with rationality as an essential feature, as Shiller notes. 

For example, in traditional finance, the Expected Utility Hypothesis, where John von Neumann and  Oskar Morgenstern enumerated axioms that define a rational decision maker, was standard. In modern finance, we have theories of rational finances from the early 1950s into the 1990, most conspicuously the Efficient Market Hypothesis. In contrast to this, there is behavioral finance which looks at systematic errors on the part of individuals. Robert Shiller made early contributions to behavioral finance with papers such as “"Do Stock Prices Move Too Much to be Justified By Subsequent Changes in Dividends?" and “Stock Prices and Social Dynamics.” In one sense Narrative Economics is a part of behavioral economics, but in another it is a deviation because it is less concerned about a regular psychology than the caprice of individual narratives and their effects on economic decisions (failure to recognize this will produce many poor criticisms of the book).  

Specifically, in Narrative Economics Shiller 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.” The term contagion carries a lot of weight here. He argues that the study of contagious economic narratives can be modeled like contagions are in epidemiology. For example, in its most simple form, an epidemic curve has a hump to it. Over a rising period the contagion rate is greater than the recovery rate (this is necessary for an epidemic to start), and over a falling period the opposite occurs. We can then discuss the particulars such as the emergence of the contagion and the factors that influenced the rate of contagion and recovery, and so on. Shiller adds: 

Similarly, with narrative epidemics there may be two different narratives, one with some minor story details that make it more contagious than the other. The minor story details make the first narrative, and not the second, into an epidemic. 

This becomes more complex as Shiller discusses constellations and confluences of narratives while constantly considering specific narratives and inserting comments about the story we might be able to tell about broader economic events – which, ultimately, is what we are really interested in, as he writes: “A key proposition of this book is that economic fluctuations are substantially driven by contagion of oversimplified and easily transmitted variants of economic narratives.” 

Shiller goes on the adumbrate “seven key propositions with respect to economic narratives” and then uses them “as a framework to look at historically important economic narratives, to identify what we can learn from economic narratives and their consequences in the real world.” And this brings us to the book’s most obvious peculiarity. A peculiarity that Shiller must be aware of. That is, on the one hand he is making very large claims about the role narratives play in economic events. On the other, he constantly tempers his comments.

For example, he picks the reader up telling them we will focus on the “brighter stars in the narrative constellations…that are significant enough to contribute substantially to changes in economic motivation.” But then sobers them by qualifying that “we cannot yet link these constellations precisely to severe economic events.” However, even with a partial grasp “we are making progress toward understanding the events.

To an extent this can be explained by the fact Shiller is trying to introduce “the beginnings of a new theory of economic change,” rather than make the full case. And this is reinforced by the final chapter of the book, titled “Future Narratives, Future Research.” But the net effect is that those who come to the book with a skeptical eye are unlikely to be persuaded.

Another reason for this has to do with the reader being provided a lot of information, but not a satisfying amount on any one thing. For example, chapter 14 is 14 pages long but contains seven sections, one of which is two paragraphs long.  

Let’s bring these together by looking at two examples: 

We are told that coinciding with the Great Depression and World War II, that is, the loss of jobs and lives, there was a narrative of modesty. And under these conditions “the reasonable response even for people who still had a job was to postpone” purchases. “such self-imposed austerity helps to explain the severe contraction at the beginning of the Depression as well as the contraction of consumer purchases during World War II.” 

And about the depression of 1873-79 Shiller writes that “In the United States, this depression is typically attributed to financial speculation leading to the banking panic of 1873, but the fear-inducing narrative about a long-term loss of jobs and job prospects due to labor-saving inventions may help to explain why the depression went global.”

If the reader is doubtful, and even has preformed views about these economic events, brief sections punctuated by comments about how narratives “may help to explain” their results are unlikely to convince them “economic fluctuations are substantially driven by contagion of oversimplified and easily transmitted variants of economic narratives.” 

As a reading experience, the book is split. Many of the examples are entertaining and topical, such as Bitcoin. Associated with the early stress on the epidemic curve, interesting plots pulled from Google Ngrams or Google Trends show the frequency of terms like “Profiteer” or “Housing Bubble” and stress the point. But there is a choppiness to book from the quantity of sections in each chapter as wells as superfluous examples: in one pointless section titled “The Yellow Brick Road” Shiller tells us how an epidemic around The Wonderful Wizard of Oz exemplifies the contagion of gold and silver narratives because some read it as a parable where “the yellow brick road is the gold standard, the silver slippers are the Free Silver movement, the Wizard of Oz is President McKinley, and the Cowardly Lion is William Jennings Bryan. Oz itself is the abbreviation for ounce, the usual unit of measurement for gold or silver.” Examples like this belong in the footnotes, and the writer just needs to get to the point. 

Narrative Economics is written in characteristically plain language. This will cause some to miss just how smart and nuanced the book is. On rereading sections one will find that Shiller has already addressed and wriggled out of many initial objections. Although it is not altogether convincing, Robert Shiller’s new book is worth the time and careful consideration– as is everything he writes. Will a study of narrative economics get “closer to the human reality behind major economic events”? We’ll have to see. 

David Murphy holds a Masters of Finance from the University of Minnesota.