Bubbles, bailouts, and banks

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Interview by Gene Zasadinski and Per Berglund

The media, old and new, are brimming with accounts of the current financial crisis. Among the punditry, only a few voices have risen above the clamor to provide clarity and insight. Chief among these is Yale economist Robert Shiller. In the following interview, Professor Shiller discusses the causes of and solutions to the economic problems we currently face. Along the way, he provides an analysis of the significance of economics in our everyday lives.

PwC: In your book The Subprime Solution, you say that the housing bubble led to the subprime and larger economic crises. You also say that people don’t understand the psychology of bubbles. Can you explain what you mean by that?

RS: Well, one very basic misperception is that most people imagine that the stock market or other speculative markets are a kind of exogenous force that we react to rather than cause. And so they don’t perceive a relation between the excitement that’s around them and the causes of the bubble. People think that their own thoughts are unique, but the reality is that millions of other people think exactly the same thoughts and act on them. And that’s what drives the markets.

PwC: So people often do not have a rational basis for their decisions. Is this the idea you develop in your most recent book, Animal Spirits?

RS: George Akerlof and I chose the words animal spirits as the title for our book because we think it’s a major driver of the economy.

PwC: Can you explain the term a bit more?

RS: Economist John Maynard Keynes used it in a famous passage in his book The General Theory of Employment, Interest, and Money. I’m not quoting him exactly, but what he meant was that there are far fewer hard facts than we might think that support important decisions we make. We just don’t have that information, and so, instead of doing nothing, we base decisions on some kind of gut feeling.

PwC: And gut feelings, particularly about the economy, can be influenced—positively or negatively.

RS: Well, this is really an interesting controversy right now. Some, even the president, are being criticized for fear mongering, for bringing up the Great Depression. The other side of it is to talk upbeat all the time. In the early years of the Depression, Herbert Hoover kept saying that he thought it would be over in a few months. And then a few months passed, and it wasn’t over, so he extended his deadline, and eventually he became the laughingstock of the nation for trying to be upbeat when obviously things were going wrong.