Shiller: The Recovery's in Our Minds, Not Our Metrics

Unemployment, GDP, manufacturing statistics — what’s the best way to tell that we’re headed into an economic recovery? According to Yale economist Robert Shiller, the answer might lie less in the metrics we use to measure economic production than it is in our own minds.

In a New York Times column, Shiller says that supposedly key economic indicators like unemployment or retail sales figures aren’t causes of a recovery, but symptoms of one. “For a fuller explanation, look beyond the traditional economic links and think of the world economy as driven by social epidemics, contagion of ideas and huge feedback loops that gradually change world views,” he writes. “These social epidemics can travel as swiftly as swine flu: both spread from person to person and can reach every corner of the world in short order.”

When stocks fall, he says, stories pop up in the media about the declines, “remind[ing] people of longstanding pessimistic stories and theories. These stories, newly prominent in their minds, incline them toward gloomy intuitive assessments.” That leads to more negative news stories, which leads to further declines, and the cycle continues, he says. The same thing happens, in the opposite direction, when stocks are rising.

This pattern doesn’t make predicting stock turning points easy, Shiller warns. But he says that it’s worth looking back after the fact to get an idea of how the tone changed during the recent market recovery. “In news media accounts and in conversations worldwide, one theme [as the market fell] was that something was fundamentally wrong with our economic system, and that it desperately needed to be fixed,” Shiller says. “The news media seemed full of stories of deceptive accounting and of crony boards of directors — not just because they were news, but also because they answered a public demand for culprits behind the price declines. These stories led to popular anger, which led business people to become more cautious in their decisions, like those involving hiring and capital expenditures. Talk of a ‘crisis of capitalism’ was everywhere. … It may be hard to remember now, but these views led to fears that the market might entirely collapse.”

Shiller says he has been monitoring a “Crash Confidence Index” for the past 20 years. It measures investors’ confidence that we will not have a crash like we had in 1929 or 1987. It hit its highest level in 2006, and its lowest point earlier this year. “Recently,” he says, “the Crash Confidence Index has been on an upswing again. Stories about market crashes are less frequent and are being crowded out by a wide variety of other, more normal narratives. The markets have repeatedly been shrugging off bad news because people have a different mind-set.”

The seemingly contagious use of the term “green shoots” is an example of this, Shiller  writes, saying that “a social epidemic is supporting renewed confidence.” That could lead to a self-fulfilling prophecy of economic recovery. But, he warns, the storyline could change at any time, pushing the market back into a downward feedback loop.

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