As Shiller explains in his more recent work, narratives are the key factor. Stories can cause humans to behave in all manner of ways, and if believed widely enough, they can shape economic outcomes. That is why it is essential to consider individual economic actors’ cognitive and emotional qualities and the ways these actors interact with one another. Group psychology is analytically distinct from individual decision-making, and in modern economies, nobody decides anything in a vacuum.
While Fama says that humans can’t beat markets, Shiller insists that it’s humans who make markets, which means that humans can strive to improve their functioning. Which claim you believe has important implications for economic theory and for financial regulation – from how much is appropriate to whether central banks should attempt to identify and pop price bubbles. If the Chicago School’s market-shaping God does not exist, we should be treating the economy as a socially constructed institution, created by and for humans, with all our biases, limitations, morals, and values.
In his Nobel address, Shiller explained that the overarching theme of his work is that we need to “democratize and humanize finance.” If we are to avoid a repeat of the 2008 global economic crisis – with all the suffering it wrought – that is exactly what we must do. To do it well, we must not be afraid to enter the economic twilight zone. Understanding markets requires understanding human social dynamics.
Antara Haldar, associate professor of empirical legal studies at the University of Cambridge, is a visiting faculty member at Harvard University and the principal investigator on a European Research Council grant on law and cognition.