Robert Shiller's Economic Views
Justin Fox, Business and Economics columnist at TIME, explains how famed economist Robert Shiller’s background led to his prescient economic views, and tells us how Shiller reacts to the economic crisis.
Robert Shiller's Economic Views
Question: What motivated Robert Shiller’s unique economic views?
Justin Fox: Shiller, in a lot of ways, was a pretty conventional economist. He
was trained at MIT in the late 60’s and early 70’s. His dissertation
adviser was Franco Modigliani, who actually coauthored a couple
of papers that led the way to the rise of rational market finance and
economics. So it wasn’t like he was being educated by a bunch of
hippies out in an Ashram or something. He was getting a very
mathematical, conventional economic education.
But at the same time, as I tell it in the book, this idea rose
simultaneously and there was a lot of cross pollination at MIT in
Chicago. But at MIT, there was always this sense of “Here is this
great model for understanding how the market works, and also, we
totally agree that the market is pretty hard to outsmart. We don’t
know that it’s smart, but it is hard for other people to outsmart, but
we we’re not so sure that means that it is all working perfectly.”
Whereas in Chicago, it became this project to show how great
markets were and how much better they were than any government
bureaucrat. So, all along, in MIT, from the beginning, it was this
weird co-existence of this very rationalist theories of how the
world worked coupled with this understanding, and a lot of
classroom discussion about how the world didn’t work quite the
way it was described in the mathematical models in the classroom.
So you’ve got people coming out of MIT, and Shiller’s classmate,
Robert Merton, a Nobel Prize winner, sort of a high priest for a
while of this rationalist finance, was there at the same time, and
came out with a very different world view. So Shiller came out
with this conventional training, but he sensed that all these theories
and models weren’t entirely right.
He had a lot of computer skills and empirical skills and so he
started during the 70’s to just try to test some of these theories
about market behavior against the data. And initially he was
looking at bond prices and didn’t come up with anything all that is
explosive. But then starting in the late 70’s he started looking at
stock prices, and was trying to come up with measure of whether
they reflected the fundamental value of the stocks themselves. He
just compared stock prices to subsequent dividend payments, and
found that the dividend payments were a lot less volatile than the
stock price movement.
And that would not proof of anything, a lot of people argued, well,
companies tried to keep their dividends smooth, therefore it
shouldn’t mean that much. But other people did similar
examinations of earnings, comparing them with stock prices, and
basically the lesson was there seem to be a lot of unexplained
volatility in the stock market.
Later on, other people, including the pretty conventional finance
scholars like Richard Roll at UCLA, basically confirmed Shiller’s
observation, and so then Shiller actually went and paid attention to
real estate for about ten years. But when he came back to paying
attention to the stock market again in the mid to late 90’s, it was
just with this idea that there were these periods when prices went
off in directions that had less to do with anything going on with the
fundamentals than just mood swings. That led him by the late 90’s
to be this really prominent doubter about the bull market of those
days. And then he came out with -- he totally admits this was luck
but the most spectacularly timed book of all time. In March 2000,
he published Irrational Exuberance, and March 2001 is exactly
when that exuberance started to tail off and end.
Question: What is Shiller’s take on the current crisis?
Justin Fox: So, he wrote Irrational Exuberance in 2000, and then he went back
to paying attention to real estate and wrote a new version of the
eBook that came out in 2005, making the point that, “Wow! Real
estate prices had gone really crazy by historical standards, and we
can probably expect sometime in the next few years a collapse in
real estate prices.” And so he is now even more of a guru than ever
before, because he really did it at some level predicted what
happened. Not on the details, not at the timing, but he -- at a time
when conventional wisdom was that the real estate market was not
a big danger, he was saying it everyday.
What’s interesting about Shiller is his lesson that he takes from all
these is not that we somehow need to shut down markets or
regulate them vastly more. However, I think he will be in favor of
some more regulation. But he seems to think that if only we had
even more financial products, if we’re all buying and selling real
estate derivatives betting that our house prices might fall, then we
would have been better off. So it sort off comes back around to that
MIT belief in markets and conventional economics in the end. And
so he’s very often paired with Nasem Taleb, an options trader
turned bomb-throwing market philosopher. And Shiller comes
across as the conservative or the moderate in all these discussions
Question: Does the crisis disprove Shiller’s belief in the power of developed
Justin Fox: His belief is continued growth of the financial system is a good
thing: we just have these shakeouts where we figure out what
doesn’t work. I guess my one caveat to that is, after he said that, I
went back, and was trying to look at it because finance people
always bring this up and there’s a lot of comparative global
research showing that countries with better developed financials do
better than those without them. But it’s mostly research about
developing countries, and it sort of stands to reason that a company
where nobody has a bank -- a country where nobody has bank
account is not going to progress as fast economically as one with
their banks and loans available.
But I think once you get to a well-developed economy with big
financial system, I’m sure there’s some point of diminishing
returns, and it’s pretty clear we reached that in the U.S. over the
past decade, where you get a financial system that sort of takes on
a dynamic of its own and it is no longer serving the economy as a
whole, but it’s just kind of turning towards it’s own path and
sucking off lots of money from the system. I imagine we will start
getting a lot of research now about whether there is any way to tell
what’s that one point where your financial system has gotten too
big? And I don’t think Shiller would disagree with that. He just, in
the end, still believes in finance and that it can do good things for
Robert Shiller's Economic Views
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