This week, Robert Shiller received a call from Adam Smith. Really.
Shortly after hearing he had been one of three economists selected to receive the 2013 Sveriges Riksbank Prize in Economic Sciences, Dr. Shiller was called by Adam Smith. A Nobel interviewer, Adam Smith indicated that prize winners typically answer a few questions right after hearing the news.
The interview follows but first a bit about Dr. Shiller’s work.
Robert J. Shiller will be recognized for explaining how human behavior affects the formation of asset prices that range from stocks to houses.
In his 2009 book, Animal Spirits, co-authored with George Akerlof (2001 Nobel economics laureate and Janet Yellen’s husband), he tells us that there is more to pricing houses and stocks and other assets than Adam Smith’s invisible hand. Instead, “…Keynes’s animal spirits are the keynote to a different view of the economy.” Like Keynes, Shiller considers the irrationality that the human element contributes.
In a 2008 econtalk interview, Dr. Shiller spoke about home prices. Quantitatively, his S&P/Case-Shiller Housing Index explanation was fascinating. Before the index, home price averages had been based on a median. His index eliminated the way medians can skew data when they, for example, include outliers and therefore sound higher than they might be. Behaviorally and equally interesting, he then explored why housing prices can soar from phenomena like exaggerated optimism.
The S&P/Case-Shiller Housing Index:
In the econtalk interview, he perfectly described a bubble as a “list of symptoms” that include:
- rising speculative asset prices that make people expect prices to rise
- a contagious social epidemic
- a spreading common story
- increasing envy as trading successes multiply
- ascending investor self-confidence that convinces many people they are geniuses
It can’t go on forever.
Sources and Resources: An excellent interview for grasping Dr. Shiller’s work and how he compares to other economic thinkers, the econtalk hour long discussion and transcript are ideal. Also, very readable, the Shiller Akerlof book, Animal Spirits, conveys in everyday language how our irrationality affects asset prices. To complement Dr. Shiller’s work, you might want to read about the other economists who won the 2013 economics prize because their ideas differ from his.
The Nobel interview with Adam Smith:
[AS] We have a tradition of recording very short interviews with new Laureates – could we just speak for a few minutes?
[AS] Thank you very much indeed. Well first of all, many congratulations on the Prize.
[RS] Thank you.
[AS] How did you hear the news?
[RS] I was getting ready to leave on a trip to Phoenix, Arizona, getting dressed, and I got called.
[AS] (laughs) And, what was your first reaction?
[AS] Do you think the trip to Phoenix is going to go ahead?
[RS] Well, it’s at least postponed and it may be cancelled.
[AS] How do you think the day is going to pan out? (laughs)
[RS] (laughs) I don’t know, the phone is ringing an awful lot.
[AS] (laughs) Have you imagined yourself in this position before? Have you imagined how you might react to it if the news came?
[RS] Well, I certainly imagined, because friends of mine repeatedly tell me they think that … they expect me to win it. But I’ve always reflected that there are so many worthy people, that it’s difficult to … I thought it was a very low probability.
[AS] Who was the first person you told, after the household?
[RS] I woke my wife up and told her. Then I told the limo driver to cancel my limo.
[AS] Very practical. (laughs)
[RS] Well, I had to do it!
[AS] But, I just wanted to ask you how, just one question, because this is going to expose your field of research to a very wide audience, who won’t previously have been aware of it. It’s all to do with the predictability of asset pricing. How good a handle do you think we have on that? Do you think it’s very much a work-in-progress or have we got things pretty well worked out?
[RS] It’s very much a work-in-progress, yeah. Well I could briefly say that it’s … we’ve learned a lot about asset pricing, but there’s a basic human element in it that is irreducible. So, predicting what asset prices will do is partly similar to trying to predict what one person will do, and so could there ever be a science in predicting what you, Adam, will be doing? No, because there’s an irreducible human element. And that’s part of the reason why the field of finance will never completely understand asset pricing movements.
[AS] That was a lovely, very understandable comment. Thank you very much indeed.
[RS] Alright. (laughs)
[AS] Okay, so I look forward to talking again, at length, later in the autumn ([RS] Good). But for now, let me wish you a wonderful day, and congratulations.
[AS] Thank you.