Robert Shiller on the Next Bubbles

When it comes to market bubbles and how they are created, very little, if anything, has changed. This is because human psychology has not changed. Massive bubbles are created when large numbers of people buy into "new era" stories that exaggerate how much the world has improved. For example, in the past few years the global equities and housing bubbles were driven by a giddy faith that world markets were on a tear and prices would go up indefinitely. Our animal spirits are sparked by these tales; we find them irresistible. And since as animals we're also given to a herd mentality, in a bubble we tend to invest too much in the most popular stories—and continue to do so even after the bubble bursts.

As I wrote in my book irrational exuberance in 2000, one of the key stories of our time is the triumph of capitalism. This theme was underscored by the disintegration of the Soviet Union and China's shift to a market economy. But many true believers got the details wrong—and became convinced, for example, that capitalism means market prices will always go up.

In the several decades since the worldwide rise of market economies, our perceptions of ourselves have changed greatly—while young people back then might have become hippies, deeply skeptical of business, today's young people are very concerned with making money. They might have temporarily questioned the idea of capitalism after the financial crisis, but quickly shrugged off their qualms. People still largely believe in the ownership society and in markets. They believe in the importance of doing business, and they generally believe that we all have a responsibility to take care of ourselves. So much for the idea that we're all socialists now; while many countries do take care of society's losers to a significant extent, we don't idealize doing so, as we once did. And this unadulterated belief in capitalism helped to fuel the bubbles that led to the crash.

Yet old ideas about markets—especially the notion that they always go up—have changed far less than you'd think. My partner, Karl Case, and I (founders of the S&P/Case-Shiller home-price index) recently conducted a survey of people's expectations of the U.S. housing market and found that, despite all the problems of the past few years, Americans still expect prices to rise over the mid- and long term—even though my data show that between 1890 and 1990 real home prices actually didn't increase.

Bubbles are also encouraged by the Internet and by high-speed data transmission. People pick up ideas in newspapers, via TV, or online, then spread them via word of mouth. Anyone who's ever played the children's game of telephone knows that, once started, a story or idea takes on a life of its own. It's probably no accident that the tulip mania of the early 1600s occurred around the time the first newspapers and pamphlets began circulating, and that the crash of 1921 coincided with the first mass radio broadcasts. The Internet helped fuel the tech bubble and the financial crisis. I have no doubt that new social media like Twitter or Facebook will contribute to the next craze, or that the Internet will have other, unexpected effects on markets as well.

Still, shouldn't we learn something from our past mistakes? The good news is that some of us do. In some cases, it's generational—there's evidence to suggest that people learn best from seismic events that happen to them in their youth (which is why the Great Depression resulted in lifelong behavioral shifts for many people). In other cases, however, people simply don't pay attention to the right information—or it may take them a while to come to it. Economics is an imperfect science, and it often goes off on tangents. For example, a few years back, economists were enamored with the efficient-markets theory—the idea that the markets always know best. Now, post-crisis, that's finally changing, and even the G20 recently issued a warning about bubbles. But while this awareness may help keep them in check for a few years, it won't eradicate them.

Nor will it be the end of the world when we go through the next one. The triumph of capitalism remains a powerful story, and no matter the shocks to come, we're unlikely to forget it.

Join the Discussion