On bubbles, reflexivity, and narrative economics

NOBEL laureate and Yale economics don Robert J Shiller has shown remarkable prescience over the years. In his New York Times best-seller Irrational Exuberance, he successfully called the dot-com bubble. Less than 10 years later, in the run-up to the financial crisis, he issued similarly accurate warnings about the bloated housing market. Of course, Professor Shiller is known for more than just his forecasting abilities. The cyclically adjusted price earnings (CAPE) ratio, or the Shiller CAPE, has become a pillar of modern finance and grew out of research that earned him the 2013 Nobel Prize in Economics. It's been almost two years since he last spoke with CFA Institute, and with talk of inverted yield curves, overvalued stock markets, and imminent recession, the present struck us as an opportune time to see what was on Prof Shiller's mind. What follows is a lightly edited transcript of our discussion.

CFA Institute: You issued accurate irrational exuberance warnings before. Does anything worry you today?

Robert J Shiller: Boy, that's a big question. What I've emphasised recently is a housing market boom and also a stock market boom together. They both show signs of disruption right now, which is a little unusual as these two markets are not very correlated with each other historically. We had the correction in the stock market from a peak at the beginning of 2000 until 2003, but then the housing market just continued to boom right through the whole thing. It's a little difficult to speak of the two as two different aspects of the same phenomenon. I am struck though that we have seen since 2009 an extraordinary behaviour of the US stock market. Since 2012, we see a pretty extraordinary behaviour of the housing market. Also, of course, you add the bond market, which has recently showed some bubble-like aspects as well.