Narrative Economics: Meaning and Traces in the World Today

Introduction

The term ‘Narrative Economics’ has been used multiple times to explain some recessions and many economic phenomena by economists and has become a trending term after Robert J. Shiller (an American economist, academic and author) wrote on Narrative Economics. Finding the concept intriguing, I decided to write on my understanding of the concept of narrative economics and where it may seem to hold true.

Narrative Economics is a study of narratives i.e., viral stories that cause certain economic events, generally events that oppose the rational economic behaviour. The ‘viral story’ can be in the form of any joke, theory, meme, song, plan, etc. that resonates with large number of people and that generally spreads through word of mouth, social media, etc. At this point, many of us may think about Dogecoin which is, in my opinion, a classic example of irrational economic behaviour by investors (or rather naïve investors) in the cryptocurrency industry because of a viral story (a meme). 

Before we talk about the examples where we observe narratives creating certain economic phenomena, it is desirable to dive a little deeper into how narratives work and transition into such impactful phenomena. I really appreciate how Robert J. Shiller uses contagion of diseases to explains this connection. Contagion i.e., spread of the narrative (the story) is at the core of narrative economics to hold. There must be viralness of the story to prove an economic phenomenon was caused because of the story. For example, in the case of Dogecoin, it was a meme that was spread on social media, which people fell for, and consequently affected its price as we have observed.

Many economic events have been caused because of viral narratives which is why it is important to know this concept. Whether you are a retail investor or the CEO of a company or a Central Bank governor, these viral narratives can cause serious economic turns that can have long-lasting impact on the entire economy.

Past evidence shows the relevance of narratives in economic events – although it is difficult to predict which narratives will have an impact and the intensity of the impact, it is good to be aware and cautious. It is important to see the broader picture based on the most popular narratives flowing around the society. One narrative may not be enough to cause an impact but a collection of narratives in a similar direction are highly likely to drive the economy or the asset (or anything at the crux of it) to that direction. Another important feature of narrative economics is that (1) a narrative with a certain impact in the past may not have a similar impact today or in the future and (2) narratives that go viral need not be true (regardless of the availability or non-availability of the truth). Going back to the Dogecoin example, everyone knew it was a Meme Coin, still it was intriguing for investors or traders to probably earn short-term gains (basically banking on the effect the narrative will have on the coin’s price).

Traces of Narrative Economics

1. Indian stock market reaction during the NBFC crisis

IL&FS, one of India’s major NBFCs, defaulted on its interest payments in 2018 because succinctly its loans to infrastructure and real estate sectors defaulted (because of the demonisation and Goods and Services Tax implementation effect) and it used its working capital loans (short-term) to pay off long-term debt which eventually fell out. As a result, its stock price plummeted. IL&FS was ‘too big to fail’ and was compared to the Lehman Brothers from the 2008 crisis. It created a temporary bottleneck in the Indian Economy. Subsequently, other NBFCs were looked upon cautiously. DHFL, another major NBFC, was targeted in a narrative that it defaulted in its loan repayment (which was false) and its stock plummeted. Evidence from sample survey taken as part of my dissertation suggests that the retail investors changed their portfolio of assets away from NBFCs after this crisis and some sold off their holding in DHFL believing in the rumour that DHFL defaulted on its loan repayment. In fact, many sold-off almost all the Banking and Finance stocks from their portfolio because of the panic build first by IL&FS default and then the DHFL rumour. A rational economic behaviour would be to sell-off only IL&FS stock and not DHFL. However, investors acted irrationally in the case of DHFL because the trust in the NBFCs was weakened by IL&FS. This phenomenon resonates with the Narrative Economics theory.

2. Dogecoin (the Meme Coin)

The story of Dogecoin is simple – some people tweeted that it is next big thing after Bitcoin and some jokingly mined it. Its price spiked and corrected and was muted till this year. Then Elon Musk tweeted about Doge and its market capitalisation reached record high levels in May at around $90 billion. The coin has nothing exceptional within itself except that some people joking drove its price. This is a classic example of narrative economics where the price of an asset was driven irrationally by some tweets by some famous people.

3. Optimistic stock markets today (to some extent)

Throughout the coronavirus pandemic the global markets have observed panic selling frequently relative to the number of positive cases in a country. However, this time, although the Omicron variant is spreading faster, investors are being rational by evaluating that it is not as bad as past variants and hence, we see the stock markets still reacting positively. Apart from Omicron, the fear regarding inflation and supply chain issues are also events that may have driven the stock markets down. But that is clearly not the case at this moment (though bond market is responding to inflation expectations and more than that, the interest rate changes to control inflation). This is because the overall narrative in the world economy is positive – despite tightening of policies and covid restrictions, people know that the economy is running regardless. We can say that people are highly likely accepting to live with covid – somewhat aiming to become resilient. This is not directly linked to narrative economics, but this is not ideal in terms of basic economic reaction one would expect in the stock markets at this time.

Parting Thoughts

Narrative Economics is quite abstract. Economists would understand it better. However, understanding it is important to understand the macro dynamics and make informed decisions, especially during a crisis. Someone who understand this concept would have not fallen for many false narratives and profited by not following the herd. 

Disclaimer: This was my perspective on narrative economics and in no way is a tip of any kind. It is only intended to help the reader understand the concept and possibly make informed decisions in the future.