Wed, Sep 26, 2012 - Page 9 News List

Remembering the stories behind global weakening

By Robert Shiller

Recent indications of a weakening global economy have led many people to wonder how pervasive poor economic performance will be in the coming years. Are we facing a long global slump, or possibly even a depression?

A fundamental problem in forecasting nowadays is that the ultimate causes of the slowdown are really psychological and sociological, and relate to fluctuating confidence and changing “animal spirits,” about which George Akerlof and I have written. We argue that such shifts reflect changing stories, epidemics of new narratives and associated views of the world, which are difficult to quantify.

In fact, most professional economists do not seem overly glum about the global economy’s prospects. For example, on Sept. 6, the Organisation for Economic Co-operation and Development (OECD) issued an interim assessment on the near-term global outlook, written by Pier Carlo Padoan, that blandly reports “significant risks” on the horizon — the language of uncertainty itself.

The problem is that the statistical models that comprise economists’ toolkit are best applied in normal times, so economists naturally like to describe the situation as normal. If the current slowdown is typical of other slowdowns in recent decades, then we can predict the same kind of recovery.

For example, in a paper presented last spring at the Brookings Institution in Washington, James Stock of Harvard University and Mark Watson of Princeton University unveiled a new “dynamic factor model,” estimated using data from 1959 to last year. Having thus excluded the Great Depression, they claimed that the recent slowdown in the US is basically no different from other recent slowdowns, except larger.

Their model reduces the sources of all recessions to just six shocks — “oil, monetary policy, productivity, uncertainty, liquidity/financial risk and fiscal policy” — and explains most of the post-2007 downturn in terms of just two of these factors: “uncertainty” and “liquidity/financial risk.” However, even if we accept that conclusion, we are left to wonder what caused large shocks to “uncertainty” and to “liquidity/financial risk” in recent years, and how reliably such shocks can be predicted.

When one considers the evidence about external economic shocks over the past year or two, what emerges are stories whose precise significance is unknowable. We only know that most of us have heard them many times.

Foremost among those stories is the European financial crisis, which is talked about everywhere around the globe. The OECD’s interim assessment called it “the most important risk for the global economy.” That may seem unlikely: Why should the European crisis be so important elsewhere?

Part of the reason, of course, is the rise of global trade and financial markets. However, connections between countries do not occur solely through the direct impact of market prices. Interacting public psychology is likely to play a role as well.

This brings us to the importance of stories — and very far from the kind of statistical analysis exemplified by Stock and Watson. Psychologists have stressed that there is a narrative basis to human thinking: people remember — and are motivated by — stories, particularly human-interest stories about real people. Popular stories tend to take on moral dimensions, leading people to imagine that bad outcomes reflect some kind of loss of moral resolve.

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