By Cassi Ainsworth-Grace

“A man is always a teller of tales, he lives surrounded by his stories and the stories of others, he sees everything that happens to him through them.” In a field that prides itself on its calculation and rationality, it feels odd to find an economist emphasising something as subjective as a story. But in his 2017 Presidential Address to the American Economic Association, Nobel-Prize winning economist Robert Shiller provided this quote from French philosopher Jean-Paul Sartre. Compared to the scientific economics we have become acquainted with; Shiller’s Address stands out like a sore thumb.

Since the mid 20^th century, economics has become leaner, and ‘more precise’ by increasing the use of mathematics, theoretical proofs and statistics. Renowned economists like Irving Fisher, Vilfredo Pareto and Eugene Slutsky were disappointed with the poor predictive power of early neoclassical economics models to anticipate economic events at the turn of the 20^th century. Early neoclassicism was built on the foundation of what we know as hedonic psychology – that individual behaviour comes to the twin goals of maximising pleasure and minimising pain. Frustration with the inability to objectively quantify the experience of pain and pleasure demanded a severing of the tie between economics and psychology. In its place, rational choice theory was developed, a theory that focuses on the actual choices made, rather than the pleasure or pain that motivated the decision.

This rational choice theory assumes that individuals have preferences to the choices that confront them. When making a decision, the most preferred choice is selected, taking into account all information, probabilities and potential costs and benefits. Despite the stereotype of rationality that circulates in popular media, economic rationality does not mean selfishness, only that we prefer our own order of preferences to anyone else. For example, a rational individual may prefer to lose a job and extra income rather than help an employer commit company fraud, given his or her preferences.

Rational choice theory has proven incredibly useful to building economic models, but we should not ignore what this theory cannot tell us. We cannot use it to understand the feelings, emotions and moods that drive a decision, nor the reasons why we pick certain choices over others. Rational choice theory tells us that we just do.

The shortcomings of economic theories like that of rationality highlights how economics is non-stationary – not governed by unchanging scientific laws like that found in physics and chemistry. Problems have resulted when lead economists like Milton Friedman have stated  that it did not really matter whether these assumptions were actually true or not, as long as economists could make reasonably accurate predictions using them. The real behaviour of individuals was simply unimportant. It is no wonder that trust in economists has fallen in recent years.

Although foundational courses in economics have seen an ever-growing integration of statistics and mathematics, the intellectual challenge spearheaded by Shiller, among others, hints at a brewing storm. Shiller has also more recently contributed to the ongoing debate with his 2019 publication of Narrative Economics: How Stories Go Viral and Drive Major Economic Events. His core proposition: that the very science of the subject will be enriched by folding in the art of narrative economics.

This new field focuses on the impact of viral stories and ideas on economic events, as our actions are based on human interest stories rather than numbers. He poetically observes that “when we are asleep at night, narratives appear to us in the form of dreams. We do not dream of equations or geometric figures without some human element.” In other words, the economic narratives we hear can determine our decisions to spend or save, and ultimately the economy’s outlook. This is far from outlandish, as information is up to twenty times more memorable when we present it in the form of stories. One of Shiller’s favourite examples is the stock market boom in the lead-up to the Great Depression, where stories of sudden fortunes were so widespread that thousands speculated life-savings with little knowledge of companies or the markets themselves.

To Shiller, John Maynard Keynes’ seminal work, The Economic Consequences of the Peace (1919), is a prime example of narrative economics. Not only applauded for his original economic commentary, Keynes expressed an incredible sensitivity to the German reaction, anticipating the stories of betrayal and animosity that were circulated by everyday Germans perpetuated by their poor economic conditions following the signing of the Versailles Treaty. His visceral language like “vengeance, I dare predict, will not limp” and “despairing convulsions of revolution”, are far-removed from the clinical tone adopted by modern economists. By relying on rules of thumb, accepted norms of broader socio-cultural behaviour and social interactions to understand economic ups and downs, Keynes attempted to account for an economic reality dismissed by rational choice theory.  

Shiller’s Narrative Economics is far from perfect. He has little in the way of empirical evidence, relying mainly on Google Ngrams, which measures word use over time, to prove his argument. But it is an excellent beginning in an incredible thought exercise about why some economic messages stick in our minds and why others fall away into the mists of time. Perhaps, he proposes, it is based on the lyrical nature of some of the words and phrases we come across. For example, self-fulfilling prophecy, natural equilibrium and trickle-down economics all have a ring almost better suited to a poem, and as a result are easier to remember. Or it may be how quickly it is snapped up by social media and the Internet, seen with the rise of Bitcoin and other cryptocurrencies.

Professor David Tuckett of UCL builds on Shiller’s view, but weaves in psychology by drawing on his experience as a Fellow of the Institute of Psychoanalysis. He particularly stresses that the narratives we tell ourselves are key when we are living in times of incredible uncertainty. In such situations, Tuckett states that we draw on the stories of successes, failures, analogies, values, beliefs and norms to devise and justify our current actions.  If these narratives influence whether we chose to save or spend, they will have significant impact on our future economic outlook.

Although stories and narratives offer a new glimpse into our economic behaviour, these stories are not easily measured or quantifiable. The US Federal Reserve has tackled this problem through its new initiative, “Fed Listens”. Over 2019, the Federal Reserve held 14 “Fed Listens” events across the US, engaging a wide range of organisations, including small business owners, community colleges, retirees, union members and employee groups, to hear about how monetary policy affects daily life. In essence, it was an opportunity to hear the economic stories of ordinary people. A similar event was held in May 2020 to hear about the impact of Covid-19 on a cross-section of communities. By listening to people who have never even heard of anything like the production possibility frontier, the Federal Reserve is acknowledging that the economic experiences of individuals, communities and populations matter to the performance of the economy.

 The Bank of England has developed their own version. The central bank has a network of 9000 individuals classified as participants in the ‘real economy’, such as business and financial market leaders. Select groups are interviewed each month to relay their general economic experiences. As an added bonus, the central bank officials are also able to impart their own experiences to these individuals. Officials then take these anecdotes to prepare reports presented to the Monetary Policy Committee. In a Staff Working Paper, scholars from UCL, Binghamton University and Cambridge formalise this greater on-board role of social and psychological science in the devising of macroeconomic policy – that our beliefs, not only statistics and models, have a role in the policy mix. However, the Bank of England still has scope to extend their network beyond the business elite and to a broader cross-section of British society.

The Reserve Bank of Australia has gone a more traditional scientific route, by attempting to quantify what economic belief is dominating the general talk. By developing a ‘news sentiment indicator’, the Reserve Bank of Australia is seeking to better understand the links between the news, broader public sentiment and economic activity. This new indicator tracks the balance of positive and negative words used by Australian journalists in articles about the economy in over 600 newspapers. Updated on a daily basis, this new addition to our economic tool-belt can pick out turning points in broader public mood in real-time, as well as the economic narrative that is currently dominating the economy.

On the flip-side, spinning economic narratives has also long been a tool of our central banks. Over the last 30 years, modern inflation-targeting by central banks have relied on the construction of a persuasive economic narrative. This has been crafted through carefully chosen words when delivering statements, reports and speeches to the public. And the central bank must be careful when doing this. For whilst it is the central banks that are seeking to maintain this inflation target, it is the public that determines most of the prices in our economy through their spending and saving patterns. If the public believes the narrative that inflation will remain around target, then their economic behaviour will reflect this.

The rise of narrative economics does not mean we should throw out all the economic models we have developed so far. It is difficult to quantify, highly subjective and interpreted differently person-to-person. Instead, narrative economics offers an opportunity to re-examine and improve existing models to better account for the incredible breadth of human behaviour, as well as simply to enrich and inspire study. It reminds us that underneath the mathematics and statistics, economics is and has always been a philosophical, moral and very human subject. And because of that, we must not forget to reflect on the experiences, stories and narratives that shape its application. As the great economist Alfred Marshall wrote in his 1890 Principles of Economics textbook, “economics is the study of people in the everyday business of life.”

“The views expressed in this article are the author’s own, and may not reflect the opinions of The St Andrews Economist.”