Once upon a time, economics focused on cold, hard numbers. Enter narrative economics, the charming storyteller. It argues stories we hear and tell influence our economic decisions. We don’t just react to prices; narratives about scarcity, value, and fairness shape our choices. Like a contagious disease, a story about a hot stock can spark buying frenzies. Conversely, tales of economic doom can lead to panic selling. Narrative economics reminds us, humans are emotional creatures, and stories are powerful tools in the economic landscape. By understanding these narratives, businesses can craft messages that resonate with consumers, and policymakers can design regulations that consider the power of stories to influence behavior. So, the next time you hear a compelling economic story, remember, it might not just be about the numbers, but the narrative too.
An American economist and Nobel laureate, Robert J. Shiller‘s work on market narratives and investor sentiment helped lay the foundation for narrative economics. His book “Narrative Economics: How Stories Drive the World Economy” popularized the concept. This book challenges the traditional view of economics, which assumes people make rational decisions based solely on logic and facts. Shiller argues that stories, narratives, and cultural contexts play a significant role in shaping our economic decisions.
His book explores the concept of “narrative economics” in four parts:
- Part 1: Introduces the basics, drawing examples from various fields like medicine and history. It focuses on two key narratives: Bitcoin’s rise (starting in 2009) and the Laffer Curve (popular in the 70s and 80s). This section also offers guidelines to avoid common mistakes when thinking about economic narratives, such as the ability of old stories to re-emerge and become influential again.
- Part 2: Explores the concept of “perennial narratives” – stories that retain their influence over time and can even experience mutations that revitalize them.
- Part 3: Examines nine specific narratives that have a proven track record of impacting economic decisions. These narratives might be about consumer confidence, frugality, or job insecurity.
- Part 4: Looks to the future, exploring the current role of narratives in shaping economies and proposing areas for further research to improve our understanding of their impact.
An appendix connects the analysis of narratives to the established field of disease epidemics, potentially suggesting similarities in how ideas and illnesses spread.
Shiller argues that the SIR model, proposed in 1927 by William Ogilvy Kermack, a Scottish biochemist, and Anderson Gray McKendrick, a Scottish physician, used for infectious diseases, can also be applied to understand how ideas spread. A study on investment decisions showed people rely more on word-of-mouth than systematic analysis, similar to how diseases spread through contact. People tend to invest in local companies, reflecting a geographical aspect like disease outbreaks. The rapid rise and limited reach of interest in some stocks resemble disease epidemics. The geographically concentrated enthusiasm for Bitcoin mirrors how diseases can be localized. The SIR model’s core principles – susceptible, infected, recovered – may be adapted to understand how ideas and narratives take hold and spread through populations, even with modern communication methods. Variations of the SIR model can be chaotic, meaning small changes can lead to unpredictable outcomes.
The concept of “information cascades” describes how people might follow the choices of others, even if those choices aren’t necessarily well-informed. Following a taxi: Choosing to follow a taxi driver in hopes they’re going to the hotel is an information cascade, potentially leading to unexpected outcomes. Speculative bubbles: Information cascades can explain how seemingly rational behavior can contribute to irrational market bubbles.
Direction of Causality
Understanding the relationship between narratives and the economy is complex. There is need for considering both how narratives may be shaped by economic conditions and how narratives themselves might influence the economy.
It’s challenging to determine if stories about economic booms cause the booms themselves, or vice versa (e.g., the roaring 20s and Bitcoin).
Economists can’t run controlled experiments like scientists, but they look for “natural experiments” like historical events (e.g., gold discoveries) to infer causality. New narratives can be seen as external factors influencing the economy, creating additional “quasi-controlled experiments.”
The assumption that causality always flows from economic events to narratives is unlikely. Self-fulfilling prophecies are economic fluctuations triggered by beliefs, not necessarily reality (e.g., the sunspot theory). Narratives can mutate and spread like epidemics, potentially leading to self-fulfilling prophecies.
John Maynard Keynes: Narrative Economist
John Maynard Keynes’s prediction about the consequences of the Treaty of Versailles and emphasizes the role of narratives in economics. The success of Keynes’s prediction is attributed to both economic and narrative elements. He considered the economic burden of reparations placed on Germany, but his language (“vengeance,” “despairing convulsions”) suggests he also understood the emotional and moral narratives that would shape German responses. This passage implies that traditional economic models, focused purely on numbers and data, might miss crucial aspects of human behavior. Keynes’s success in predicting a major historical event by considering the narrative dimension suggests the value of narrative economics.
“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.”
Keynes, John Maynard. 1920 [1919]. Economic Consequences of the Peace. London: Macmillan, p. 268.
A Place for Narrative Economics in Economic Theory
Narrative economics has been overlooked, partly due to the complexity of the relationship between stories and economic outcomes. Additionally, economic discussions in media often lack academic rigor. Traditionally, economics assumed people make rational decisions. However, the rise of behavioral economics acknowledges the influence of emotions and narratives.
“Nudge units” (for instance the Penn Medicine Nudge Unit) are a recent example, using insights from behavioral economics to design policies that “nudge” people towards better choices without coercion. Leaders can shape economic narratives by countering false narratives and promoting more rational and public-spirited ones. Studying narratives is difficult because it can be politicized and emotional. Additionally, quantifying the impact of narratives has been challenging. Economists traditionally focus on quantitative data, making it hard to analyze the qualitative aspects of narratives.
However, the advancements in technology may offer new ways to analyze narratives, such as textual search of vast amounts of data. This can help to understand how narratives spread and influence economic behavior. There is a potential of narrative economics to become a more quantitative and rigorous field of study.
Side note: The mathematization of economics has been a gradual process, not a sudden switch. Pioneering figures like William Jevons, Léon Walras, and Irving Fisher introduced marginal analysis, utility theory, and general equilibrium models, all of which relied heavily on mathematical tools like calculus and differential equations. The 20th century saw a continuation and expansion of the mathematical approach. New mathematical techniques, such as game theory and econometrics, were incorporated to analyze economic behavior and test economic theories. There has been ongoing debate about the usefulness and limitations of mathematics in economics. Some argue that it provides a powerful tool for analysis, while others believe it can oversimplify complex economic realities.