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Friday, May 15, 2009

Shiller: Story Time for the Economy

Robert Shiller uses his ideas on the role of animal spirits in driving booms and recessions to cast doubt on the idea that recent sightings of green shoots portend quick recovery for the economy:

Story Time for the Economy, by Robert J. Shiller, Project Syndicate: Since hitting bottom in early March, the world’s major stock markets have all risen dramatically. ... Does this suggest that the world economic crisis is coming to an end? Could it be that everyone becomes optimistic again at the same time, bringing a quick end to all our problems?

Speculative booms are driven by psychological feedback. Rising stock prices generate stories of smart investors getting rich. People become envious of others’ successes, and begin to wonder if rising prices don’t portend further increases. A temptation arises to get into the market, even among people who are fundamentally doubtful that the boom will continue. So rising prices feed back into more rising prices, and the cycle repeats again and again – for a while. ...

But one must ask what would sustain such a movement now. There seems to be no dramatic fundamental news since March other than the price increases themselves. ... The only way world confidence can return dramatically is if our thinking coordinates around some inspiring story beyond that of the price increases themselves.

In my 2009 book with George Akerlof, Animal Spirits, we describe the ups and downs of a macroeconomy as being substantially driven by stories. Such narratives, especially those fueled by accessible human-interest stories, are the thought viruses whose contagion drives the economy. The contagion rate of stories depends on their relation to feedback, but plausible stories have to be there in the first place. ...

The stock markets’ rebound since March seems not to be built around any inspirational story, but rather the mere absence of more really bad news and the knowledge that all previous recessions have come to an end. At a time when the newspapers are filled with pictures of foreclosure sales – and even of surplus homes being demolished – it is hard to see any cause for the markets’ rebound other than this “all recessions come to an end sooner or later” story.

Indeed, the “capitalists triumphant” story is tarnished, as is our faith in international trade. So, here is the problem: there isn’t a plausible driver of a dramatic recovery.

Starting an economic recovery is like launching a new movie: nobody knows how people will react to it until people actually get to see it and talk about it among themselves. Our efforts to stimulate the economy should be focused on improving the script for those stories, making these stories believable again.

This means making capitalism work better, and making it clear that there is no threat of protectionism. But the rationale must be to get the world economy out of its current risky situation, not to propel us into yet another speculative bubble.

    Posted by on Friday, May 15, 2009 at 01:44 PM in Economics | Permalink  TrackBack (0)  Comments (21)

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