Have you ever wondered why the stock market and economies often behave in strange ways? Many economists will say that it is all about numbers and statistics. So the only way to understand the economy is to interpret these statistics?
Not really, the people who drive our economies are the consumers, businesspeople, and politicians, which are more complicated than any statistics can reveal.
Humans have their own passions, biases, and belief systems. These are the stories that change the way we behave, which impacts the way money behaves.
When these stories become popular, they can drastically change economic outcomes, whether that is causing panic during a stock market crash or leading to the rise of Bitcoin. Narrative economics shows how these collective stories drive economic events.
What is narrative economics?
The economists mostly speak in figures on TV, and they use terms like GDP or inflation describing a past stock market crash or a recession. Economists rarely explain the economy by referring to people's fears, hopes, and judgments. They often leave out the messy human stories that are important to understand big economical events.
This is where narrative economics comes in. To understand the phrase, you need to consider the use of the word narrative. It is simply something with a beginning, middle, and end. A narrative can describe a collective Story or a belief shared by a group of people.
Take the "shrewd businessman" where Donald Trump capitalized on it to get more voters. If Trump is a shrewd businessman or not doesn't matter. He successfully narrates and plays up his credentials to a tough operator who gets the country's best deals.
This particular narrative had a real effect; it helped Donald Trump to was an elected president.
Or the example of the stock market crash of 1929. In the years before the crash, there were a lot of popular narratives from ordinary people that gambled all their savings on a particular stock to become very rich. This resulted in more people making bad investments, which led to the big crash on October 24, 1929.
Narratives should form a part of our understanding of any economic event, but economics rarely focuses on these stories.
The mystery behind Bitcoin
In late 2008 someone calling themself, Satoshi Nakamoto posted a link to the paper for a Peer-to-Peer Electronic Cash system named Bitcoin. From that moment on, excitement grew around this mysterious innovation. While the true identity of Nakamoto has never been revealed, their invention, the cryptocurrency Bitcoin, has become a phenomenon.
There is a complex and impressive mathematical theory behind bitcoin. But it isn't the technical achievement of cryptocurrencies rather the mystery and excitement that drives interest in it.
Most investors don't know the answer when you ask about the technology behind the crypto coin. Instead, what excited most Bitcoin investors is the narrative around it. The promise of a new solution, far from the old currencies that displayed dead presidents, kings, and queens.
Future investors believe that if they invest in cryptocurrencies like bitcoin, they have a stake in the future, which is very exciting. The buying of crypto makes many feel they are among the enlightened and technologically advanced people rather than being left behind with everyone else.
Another popular idea of Bitcoin is that it's outside of the control of big banks and governments. It makes the currency even more attractive for investors who believe that institutions have become corrupt and inefficient. The currency doesn't belong to one country, which appears as an idea of internationalism. This gives "Bitcoiners" the thinking that they are savvy and future-orientated citizens of the world.
From the mysterious founders and the complex math, the idea of a new futuristic international currency makes Bitcoin an attractive story. Without that story, the cryptocurrency most likely wouldn't be as successful attract millions of investors.
It shows the perfect illustration of the power that narratives have in the world of money.
Why epidemics and the Stock Market are similar?
All of the different departments at a university like literature, physics, mathematics, economies, and so on are highly specialized and provide all wonderful insights in their respective fields.
But the overspecialization can be an obstacle as its focus is too narrow. Instead, by working together, these departments can enrich each other. One area could be economics who could learn a great deal from the study of epidemics.
When you look closely at how diseases spread, you can gain many insights into the narratives of epidemics. Take contiguous disease like a strain of coronavirus. There is a contagion rate, a recovery rate, and a dearth rate. When the epidemic is rising, the contagion rate counts all-new infected and therefore outnumbers both the recovery and death rates.
If epidemic numbers decrease, the process is reversed, and those recovering or dying outnumber new cases.
The same pattern can be applied to continuous economic narratives. A contagion occurs from person to person through face-to-face conversation, social media, or other communication forms. It also spreads through news, talk shows, and the whole media ecosystem.
First, it rises rapidly, just like a disease epidemic then there is a slowing process, rather than recovery people lose interest or forget. When these people outnumber those contagious and those who spread the narrative, the story will die quickly.
The Gamestop story provides a great example of the parallels between a disease and a contagious narrative. Only look at how the Gamestop stock suddenly rise. A member of the Reddit Group, Wall Street Bets, discovered that certain hedge funds were heavily shorting and betting against the stock.
It started as an epidemic virus when the Reddit Group members wanted to see if they could make the hedge fund lose money by betting heavily on the Gamestop shares. The wave was successful, and the price went 1700 percent up, and it hurt the large hedge funds that had been short selling and betting against Game Stop stock. Some of these funds experience huge losses.
But similar to a disease epidemic, there was this sudden spike and peak, and now the Game Stop Stock drops in price, and individual investors also lose a huge amount of money. However, some believe the price will go back up, which would be a second wave after the initial spike. Only time will tell how this story will go on and if it brings new regulations.
It shows disease epidemics, and narrative epidemics follow a similar shape. By studying the pattern of epidemics, we can get ahead of certain continuous stories and use economic and political responses accordingly.
How small details can change a story
Sometimes a story only gains momentum when it connects to other relating stories.
For example, your next-door neighbor is an anti-social person who puts spikes on their garden fence so cats can't enter. So if a cat suddenly went missing in your neighborhood, the narrative that your neighbor hates cats would seem more important than ever.
You might begin to notice other relevant details about your neighbor, which fit your overall impression that he is a miserable person regardless of what happened to the cat. This is because narratives rarely happen alone rather, they are often a part of a wider net of related stories.
When someone urgently wants to share an idea, it can be stuck with people.
If we seek to understand one popular narrative, we have to be careful not to miss the related ideas surrounding it. Otherwise, we only see a tiny part of the bigger picture. So it is important to be open-minded.
It is in our nature to look for a form of narratives whenever we can. The mind shapes everything into narratives, and to form them, we particularly use human details.
Sometimes, there are small details in court cases, like when the accused said: he accidentally knocked over a food bowl on the white carpet. This vivid small detail makes the whole crime narrative not as dry and colorless anymore, which can also influence how a jury sees the crime.
In economics, these particular details can help build narratives with dramatic effects. Only think back to the terrorist attack of 9/11. At the time, the US economy was already in the middle of a recession. And as the World Trade Center was destroyed and the Pentagon was badly damaged, many economists have feared that the confidence in the economy would fall further.
While all indicators pointed to this fear, in November the recession astonishingly was over. It appeared that the American people who saw this terrible attack on those symbolic buildings, turn this seamless narrative of a further recession around.
Rather than accepting the continuing recession, the Americans had created their own narrative around these details. So US businesses and the whole economy responded accordingly.
The difference between Panic and Confidence
Another very common narrative is panic versus confidence. Often journalist politicians and economists talk about confidence in businesses, banks, and the broader economy. But economists need to have confidence in other people when they want to thrive.
In the United States, the word panic was already describing a financial crisis, the famous Panic of 1907. Where the banker J.P. Morgan used his own money to help bail out the banking system.
The flip side of collative panic is collective confidence. The importance of confidence can be found in the statement of President Calvin Coolidge. He wanted to boost public belief in the stock market. To this, Coolidge gave optimistic public statements about the economy even when things weren't looking so good.
During the stock market crisis in 1929, the word "crash" was used to refer to the fall of the stock market. These stock market crash narratives came back in 2007-2009 during the Great Recession. Like in the 1920s, it was the idea that the crash was an inevitable punishment for a period of reckless speculation.
These narratives have roots in events long ago but also shape current events. So if we want to understand better what is happening now, we need to recognize that we experience a mix of these stories.
Many of our memories change over time, be it a distant birthday party or a summer road trip with friends. These memories can reappear throughout our life differently and cause us to rethink them completely. So the party wasn't as bad as you first thought because you made new friends.
In economics, it is similar the collective narratives can change through time and give a whole new understanding.
Take the start of World War One, where investors responded with panic and irrationality. For instance, Europeans shipped out massive amounts of gold of the United States, even if they weren't part of the war yet, the stock market began to fall.
But as World War Two began on September 3, 1939, the S%P index rises by 9,6%. Why? There was a different popular narrative about World War One. Many believed those who would hold their investments during the war had to become rich. Between 1918 and 1939, the First World War's narrative change caused people to act dramatically differently.
Using Narratives for the economy
Narratives are important when it comes to the economy. They can help to predict downturns and boom periods or other anomalies. So economists need to take them seriously because it is not enough to use statistics.
Economists and research use technological tools to understand narrative better and find patterns in the ocean of data. So they identify prominent narratives that have common effects on the economy.
By better understanding these stories, policymakers will shape people s behavior better in times of great stress. President Roosevelt understood this in 1930 during the Great Depression. He knew that collective confidence was an important factor in the economy. As a response, Rosevelt used the "fireside chats" to take the fear of people going out and spending money.
By doing this, he took control of the narrative, and it seemed to work each time he addressed the nation; the markets became steady again.
When policymakers are able to read the narratives around approaching or present economic events, they get a great head start. So they can be active participants instead of helpless bystanders.
But this is not the only solution for a better economy.
There are certain experts who will say the past few decades were an economic success. The statistics and key indicators like GDP are on the rise. Also, productivity is at an all-time high. Yet all around the world, people protest angrily in the streets.
A factor is that the financial world intersects with our emotional well-being. There is a connection between economic policies, populist movements, and the feeling of anger, stress, and uncertainty that most of us have daily. A problem is the elite institutions, which structure the global economy, have mismanaged their responsibilities.
How does capitalism work?
Capitalism is similar to a computer; it relies on hardware and software to work properly. The hardware of capitalism are society's institutions like banks, stock markets, or governments. And the software that tells everything how to interact in society's ideology is free-market liberalism or social democracy.
Like a computer, you can design a capitalist society with different combinations of hardware and software. Some mixes work well and are relatively stable, and others don't work so well.
Over time the software has bugs, the hardware might overheat, and the whole system will crash.
And when this happens, people get very angry.
There were three major versions of capitalism since the mid-1800s. Each one has operated a few decades before facing major problems and requiring a reboot.
The first problem was the "software" the markets were always right and the "hardware" the state should not interfere. This worked until it began producing widespread poverty and unemployment. It caused a crash, which was the Great Depression, and helped ignite World War 2.
After 1945 we made a fresh reboot to a new capitalism machine. The "software" was based on the Keynesian economic model, with more hardware power to labor unions and states and less power to investors and markets.
This generated widespread economic growth as well as a strong middle class. But it also had its "bugs" that produced a lot of inflation and disappointing low return on investments.
In the 1970s and 80s, things were again redone and rebooted. And the "software" was called neoliberalism with "hardware" that included labor unions, unfettered free trade, and government. The "bugs" produced high inequality, and banks that overlend collapsed inventible.
This was the latest version of capitalism that crashed in the financial crisis of 2008.
But unlike the previous crash, we didn't update the machines. Instead, those in power simply made a few and changes and pressed restart. Everything is operating again with the same bugs that produce the same problems, only worse.
Why is today's economy so stressful?
Our daily lives have become less stable, and the future is more uncertain, which is stressful and tiring.
But which economic processes are causing stress? There are four main trends that give many everyday people anxiety.
- The rapidly evolving market where the industries get deregulated has many technological changes. This makes the economy very competitive. So companies need to innovate constantly to stay up to date. It means the worker also needs to adapt and put in the extra hour to learn new skills, which is stressful and extra pressure.
- Some people fear that jobs will be automated away when innovations like Artificial Intelligence are more used. While this is only a possibility in the long future still many companies will adopt the cost-saving measure. It makes it difficult for workers to feel in many industries secure in the long run.
- There is an economic orientation towards the older generations. The people that grew up in the post-war economy enjoyed many social programs like cheap college and a strong labor market. They could accumulate lots of wealth through political decisions. But the younger generation lacks these opportunities, which give them less security.
- The imagined competition through immigration. While the upper-class enjoy diverse communities, the people who live in poorer places often see newcomers as the cause of their problems. But there is evidence that shows immigrants actually strengthen economies. Nevertheless, many politicians argue that immigrants are a problem for the already stressed social programs.
These trends create an atmosphere where no one feels really secure about their economic future. And the version of capitalism is leading the world to a bad end. So it's clearly time for a reboot.
How to make the economy better?
It isn't possible to change the whole thing. But Canada and Australia have already managed to transforms their banks and create positive outcomes, e.g., real wage growth. Maybe when it comes to updating our economy, it's easier to keep things that work and fix faults that don't.
The positive side of the current version of capitalism is that most countries have high employment rates. This is done without generating any inflation. When updating the society "hardware and software," we need to keep these outcomes while eliminating downsides like inequality and instability.
To tackle the inequality, the bottom 80 percent needs to get more wealth and assets. Countries, for example, can use historical low-interest rates to set up a National Wealth Fund. So the government can borrow money by selling bonds and then invest that capital in diversified mutual funds. So every few years, the returns will be given to citizens to spend on housing, education, and healthcare.
Similar systems are already set up in places like Norway and Singapore.
During the last recession, central banks helped the market by giving giant bailouts to corporations. A better solution would be to transfer wealth to citizens. It would be more effective in keeping the economy going, and it also is fairer.
While entities like the EU are valuable for international coordination, countries, and regions should be freer to experiment with new policies. It would allow them to find solutions directly to their population's needs and test out new ideas.
Countries can also get more wealthy by making big tech firms pay licenses when they use public data. Or central banks could give cheaper interest rates when businesses want to invest in more sustainability.
If we also consider narratives as part of our economic analysis, we get better prepared for the future ahead of us.
The overall goals are to find solutions that help with the economic trends and minimize public outrage and private stress. So those in charge need to implement more policies that serve everyday people, no only the wealthy and rich.