Economic Story Hour

Why the narratives we embrace about our finances matter


Narrative Economics: How Stories Go Viral and Drive Major Economic Events, by Robert J. Shiller, Princeton University Press, 400 pages, $27.95

In October, David Leonhardt of The New York Times published an animated chart that was supposed to show how much less progressive American tax rates had become since 1950. Back then, the animation said, the marginal income tax rate on top earners was 70 percent; now it's only about 23 percent. Meanwhile, the rate paid by the poorest Americans had gone up.

Many people retweeted the chart, including presidential candidate Elizabeth Warren. But not everyone was impressed. Economists on both the left and the right noted that the scholars behind the estimate, Gabriel Zucman and Emmanuel Saez, did not account for transfers, such as the Earned Income Tax Credit or Social Security benefits, and that they made debatable assumptions about who bears the burden of corporate taxes. Others took issue with how Zucman and Saez calculated income. Most other estimates show the opposite—that in the United States the tax code is quite progressive. Several economists were distressed that new results were released to such a high-profile outlet before being fully vetted.

But far more Americans read The New York Times than follow tax economists on Twitter. A compelling narrative has taken hold that the rich pay less income taxes than the poor. This fits snugly with another popular story—the one where there's clearly room to finance new entitlements and far-reaching environmental programs by jacking up taxes on the wealthy, without asking most Americans to pay a cent. If Warren becomes president, it will bolster her case for large tax increases. Accurate or not, the ideas behind the chart could have major consequences for the economy.

It's not the first time something like this happened.

The Yale economist Robert Shiller has spent his career arguing that human irrationality drives financial markets. His new book, Narrative Economics, asks what drives those "animal spirits." He argues that narratives, which "generally take the form of some recounting of events, whether actual or fictional," are a key factor. Often, he says, "the specific events described are little more than bits of color brightening a concept and making it more contagious."

This is a profound departure from how economists tend to think about the economy. They usually assume a recession is caused by an external shock—say, an increase in oil prices or a big rise in interest rates. How much damage the shock does depends on things like monetary policy or government spending.

Shiller doesn't deny those factors, but he argues that it is narratives about the economy that drive consumer and investor sentiment, prompting people to spend or not to spend, to invest or not to invest. In this way, narratives can cause or exacerbate a recession. Drawing data from Google Ngrams, a program that lets users search for words or phrases in books going back to the 1500s, he argues that narratives spread the way a disease does. Whether a particular narrative takes off is fairly random, like a virus mutating. But as any newspaper editor knows, viral narratives tend to have certain common features: They generally feature compelling, memorable stories that include a person you can either sympathize with or hate, often an archetypal figure. Popular conspiracy theories tend to have an us-vs.-them feature and some vague grounding in reality.

Those narratives, in turn, can change the economy. Shiller offers the example of bitcoin, which he argues became so popular as an investment, despite having no intrinsic value, because it played on several prevailing narratives, such as fear of government.

The best part of the book retells 19th and 20th century economic history through this narrative-centric perspective. Shiller spends a lot of time on the stock market crash of 1929, showing first a buildup in sentiment that money could be made in the stock market and then, after the crash, a narrative that the economy was too severely damaged for people to spend.

One of the most compelling chapters is on the housing market, the area where Shiller made his name. He describes how the narrative that a home is an investment, rather than merely a place to live, took hold in the latter half of the 20th century. Before this, land was a speculative asset, but the press rarely discussed the prices of single-family homes. This changed in the mid–20th century, when owner-occupied housing became more expensive. This coincided with data on house prices, especially house price indexes, which changed how homeowners saw where they lived. Schiller takes some responsibility for that shift, as he is the co-creator of the Case-Shiller index, which tracks real estate prices and helped fixate people on the value of their homes.

That isn't the only time the availability of new data sparked new narratives. Economists didn't start estimating inflation until the 1910s, and they didn't start measuring unemployment until the 1930s. This changed how people viewed the state of the economy. Schiller found newspaper articles from the '20s, for example, that said people weren't spending because they were waiting for prices to return to "normal"—normal being prices in 1913, the first data point in the new price index. It will be interesting to see how "big data," the new huge data sets drawn from technology that monitors our behavior, will fuel new narratives about, and thus change, the economy.

Just as narratives shape economic events, economic events shape narratives. When inflation was high and unpredictable, Shiller recounts, many people blamed unions for rising prices, arguing that they bid up wages. After decades of low, predictable inflation, the younger generation is less fearful about rising prices—and less susceptible to anti-union arguments that invoke inflation. Shiller's Google Ngram data show the phrases "cost-push inflation" and "wage-price spiral" spiking at times of peak inflation and showing up rarely now; Gallup surveys show an inverse trendline when it comes to public sympathy for unions.

The narratives Shiller discusses are mostly harmful: inaccurate stories that distort economic activity for the worse. But presumably there are benevolent narratives too, or even narratives with both benign and malign effects. Shiller is not a fan of the "American dream" narrative—the idea that any American can succeed with enough hard work or ingenuity—because he thinks it is partly to blame for the housing bubble. On the other hand, the same idea has helped bind Americans together through economic ups and downs and at times of political crisis.

Lately that idea has been giving way to a different narrative, one where mobility has decreased and the American dream is no longer true. In fact, relative mobility has not budged that much over the years; being born into certain families or locations has always improved (or lowered) your odds of success. What's changing isn't the economy but the popularity of two rival narratives—but that change could itself have repercussions for the future of the economy and the country.

Shiller's argument is compelling, but at times it feels incomplete. He could have said more about why certain narratives take off. Are some populations more susceptible to popular narratives than others? Are inaccurate narratives more likely to spread during times of economic uncertainty? Are people more attracted to stories that suggest that they—or someone—has control over the world?

And while Shiller makes a strong case that narratives deserve more attention from economists, I was less convinced when he argued that they should be included in economic forecasts. If most narratives don't have a significant economic impact, and if it's impossible to reliably predict which ones will, then including them in one's models may make those models less accurate. (That said, Shiller's suggestion that economists spend more time talking to people, instead of relying just on data, is a good one.)

It is also worth wondering how economists could use narratives not as forecasting tools but to communicate their own messages. A narrative has been brewing on both the left and the right that "globalist" economists have led policy makers astray. That notion, in turn, has helped drive support for restrictions on immigration and trade. In fact, trade and trade-friendly reforms have increased living standards, not only for the 2 billion people around the globe who have escaped poverty over the last three decades but for the vast majority of Americans. But that is not a narrative that has gained much traction.