Now might be a good time to read Nobel Prize winner Robert Shiller’s book, Narrative Economics, published in 2019.

Why now?

One of Shiller’s best known pieces of work looks at the relationship between stock prices and subsequent earnings, finding that stock prices are more volatile than they should be given the information on earnings. This finding suggests that something more than fundamentals moves prices and in Narrative Economics he suggests that “economic fluctuations are substantially driven by contagion of oversimplified and easily transmitted variants of economic narratives”.

Shiller uses the language of epidemics to argue that the stories that we are told, and those that we choose to repeat, lead us to infect one another with ideas that cause us to drive economic indicators away from fundamentals. Not only does he use the language of epidemics but he uses the models too, models which in 2019 may have seemed reserved for infectious disease specialists but, now unfortunately, greet us every day. Shiller helpfully provides an Appendix in his book as an introduction to them.

An entire chapter of the book is reserved for Real Estate Booms and Busts which covers land and residential prices as one of the “most prominent economic narratives”. He suggests that the narratives that surround the real estate markets are variations around the general theme of the scarcity of land and the value that accrues to it. It is relatively easy to see how real estate narratives can be built and how they might become contagious.

And, the extent to which stories change peoples’ perceptions of facts is worrying. A study carried out by Freymouth and Ronan in 2004* looked at the decisions that people make when considering the choice of a treatment (here for a fictitious disease) with a known percentage effectiveness, alongside a positive, neutral or negative anecdote. The control was a treatment that was 50% effective. Unfortunately, when accompanied by a positive anecdote, 78% of people preferred a treatment that was 30% effective. Similarly, when a treatment with 90% effectiveness was the alternative to the control, if it was accompanied by a negative anecdote only 39% of people chose it.

We are all potentially susceptible to the power of stories, but, of course, we think we are not. The next time you are being sold a real estate investment it would be worthwhile thinking about how much of what you are buying is a story. It would also be worth asking, when you see a market rising (or declining) how many other people bought the story that got it there.

* Freymouth, A and Ronan, G (2004), “Modelling patient decision-making: the role of base rate and anecdotal information” Journal of Clinical Psychology in Medical Sertings, no. 3, pp. 211-216