Narrative Economics

1. Economic narratives spread like epidemics, influencing major events

Ultimately, narratives are major vectors of rapid change in culture, in zeitgeist, and in economic behavior.

Viral spread of ideas. Economic narratives follow patterns similar to disease epidemics, with contagion rates, recovery rates, and mutations. They can spread rapidly or slowly, affecting small or large portions of the population. The spread is influenced by factors like repetition, human interest, and attachment to celebrities or cultural identity.

Impact on economic events. These narrative epidemics can significantly influence major economic events like recessions, depressions, and financial crises. For example, the spread of stories about bank failures can lead to actual bank runs. Understanding the dynamics of narrative spread can help explain and potentially predict economic fluctuations.

Key epidemic model components:

• Contagion rate
• Recovery (forgetting) rate
• Mutations
• Super-spreaders

2. Contagious stories shape public perceptions and economic behavior

When assessing the probability that quarterly US GDP growth will be negative one year in the future, their predictions have had no relation to actual subsequent negative growth rates.

Power of storytelling. Contagious narratives have a profound impact on how people perceive economic conditions and make decisions. These stories often have more influence than traditional economic indicators or expert forecasts. The human brain is wired to respond to and remember stories, making narrative a powerful force in shaping economic behavior.

Economic decision-making. People often base their economic decisions on prevalent narratives rather than on purely rational analysis. For instance, stories about a housing bubble can influence whether people decide to buy homes or how much they're willing to pay. Understanding these narrative influences can provide insight into seemingly irrational economic behaviors.

Examples of narrative influence:

• Consumer confidence
• Investment decisions
• Spending patterns
• Policy support

3. Recurring narrative themes persist through history with mutations

The seeds of the world financial crisis were planted decades earlier.

Perennial narratives. Certain economic narrative themes recur throughout history, adapting to new contexts and technologies. These include stories about financial panics, technological unemployment, real estate booms and busts, and the morality of wealth accumulation. Recognizing these recurring themes can help in understanding current economic narratives and their potential impacts.

Narrative mutations. While core themes persist, narratives evolve and mutate over time. For example, fears about machines replacing jobs have existed since the Industrial Revolution, but the specifics of the narrative have changed from mechanical looms to artificial intelligence. These mutations can refresh old narratives, making them newly relevant and contagious.

Examples of recurring narratives:

• Financial bubbles and crashes
• Technological disruption of jobs
• Wealth inequality and its consequences
• Government intervention vs. free markets

4. Confidence and panic narratives drive economic fluctuations

Panic is in its nature unreasoning; therefore, although the financial fright of 1893 arose from fear of depreciation of the legal tenders [federal-government-issued paper money], the first act of frightened bank depositors was to withdraw these very legal tenders from their banks.

Cyclical nature of sentiment. Economic confidence and panic narratives tend to alternate, driving cycles of economic expansion and contraction. Stories of high confidence can fuel economic booms, while panic narratives can trigger or exacerbate downturns. These narratives often become self-fulfilling prophecies.

Role of media and communication. The spread of confidence or panic narratives is greatly influenced by media coverage and communication technologies. The speed and reach of modern communication can amplify the impact of these narratives, potentially leading to more rapid and severe economic fluctuations.

Key elements of confidence/panic narratives:

• Financial stability perceptions
• Business outlook stories
• Consumer sentiment reports
• Crisis or recovery anecdotes

5. Frugality vs. conspicuous consumption narratives impact spending

By the 1990s, the term flipper was commonly used to describe people who bought shares in initial public offerings (IPOs) and resold them quickly.

Shifting social norms. Narratives about frugality and conspicuous consumption reflect and shape social norms around spending and saving. These narratives can shift dramatically in response to economic conditions or cultural changes, impacting overall economic activity.

Economic consequences. When frugality narratives dominate, they can lead to reduced consumer spending and economic slowdown. Conversely, conspicuous consumption narratives can fuel economic booms but may also contribute to unsustainable debt levels and inequality. Understanding the prevailing narrative can help in predicting consumer behavior and economic trends.

Factors influencing frugality/consumption narratives:

• Economic conditions (e.g., recessions, booms)
• Cultural shifts (e.g., environmentalism)
• Generational attitudes
• Technological changes (e.g., social media)

6. Technological unemployment fears recur with each innovation wave

When George," said she, "was about six years old, he was made the wealthy master of a hatchet! of which, like most little boys, he was immoderately fond; and was constantly going about chopping every thing that came in his way.

Persistent anxiety. Fears about technology displacing human workers have recurred throughout history, from the Industrial Revolution to the current AI revolution. These narratives often spike during economic downturns or periods of rapid technological change.

Economic impacts. Technological unemployment narratives can influence labor markets, education policies, and investment in new technologies. While the long-term trend has been for technology to create more jobs than it destroys, the short-term disruptions and uncertainties can have significant economic and social impacts.

Historical examples of technological unemployment fears:

• Luddite movement (19th century)
• Automation anxiety (1950s-60s)
• Computer revolution (1980s-90s)
• AI and robotics (current)

7. Real estate and stock market narratives fuel booms and busts

The Laffer curve is a diagram famously used by economist Art Laffer at a dinner in 1974 to justify the government cutting taxes without cutting expenditures, which would please many voters, if the justification were valid.

Speculative narratives. Stories about ever-rising real estate values or stock market returns can fuel speculative bubbles. These narratives often include elements of "get rich quick" schemes, new paradigms, or "this time it's different" thinking.

Boom-bust cycles. The spread of these speculative narratives can lead to self-reinforcing cycles of rising prices and increased speculation, followed by sudden crashes when the narrative loses credibility. Understanding the role of narratives in these cycles can help in identifying potential bubbles and managing their economic impacts.

Components of market boom narratives:

• New technology or paradigm claims
• Stories of ordinary people getting rich
• Dismissal of traditional valuation metrics
• Fear of missing out (FOMO)

8. Boycotts and profiteering stories shape business-consumer dynamics

Excess profit is just what its name indicates—the fruits of profiteering, usury; and if there is anything in the world that should be taxed it is that very thing. In fact, it should be punishable by prison sentence or even more severely still.

Consumer activism. Narratives about corporate misbehavior or profiteering can lead to consumer boycotts and changes in purchasing behavior. These stories often tap into broader social or economic anxieties.

Business reputation management. Companies must increasingly manage narratives about their practices to maintain consumer trust and avoid boycotts. This narrative management has become a crucial aspect of business strategy in the age of social media and rapid information spread.

Types of boycott/profiteering narratives:

• Price gouging during crises
• Unfair labor practices
• Environmental damage
• Political controversies

9. Labor union narratives influence wage and inflation expectations

The wage-price spiral narrative took hold in the United States and many other countries around the middle of the twentieth century.

Collective bargaining power. Narratives about labor unions and their role in the economy can significantly influence wage negotiations and labor market dynamics. These stories often reflect broader societal attitudes towards workers' rights and income inequality.

Inflation expectations. Labor union narratives can shape expectations about future wage growth and inflation. These expectations, in turn, can influence actual wage and price setting behaviors, potentially leading to self-fulfilling prophecies about inflation.

Factors in labor union narratives:

• Historical union achievements
• Current economic conditions
• Political climate
• Automation and job security fears

10. Understanding narrative economics improves forecasting and policy

I hope this book confirms the possibility of real progress in getting closer to the human reality behind major economic events without sacrificing our commitment to sound scholarship and systematic analysis.

Enhanced forecasting. Incorporating narrative analysis into economic forecasting can improve predictive accuracy, especially for major events like recessions or financial crises. Traditional economic models often fail to capture the impact of changing narratives on economic behavior.

Policy implications. Understanding the role of narratives in shaping economic outcomes can lead to more effective policy design and communication. Policymakers can use narrative strategies to build public support for economic measures or to counter harmful economic myths.

Applications of narrative economics:

• Crisis prediction and management
• Monetary and fiscal policy design
• Consumer behavior forecasting
• Long-term economic planning

Last updated: August 29, 2024