Interview with Robert Shiller: Figuring out financial markets: more psychology than economics?

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Page 111

LOUNGANI: The U.S. stock market crashed in 2001 as you had predicted but has now recovered from those lows. Is the correction over?

SHILLER: People seem to think the correction is largely over. My opinion surveys show many people are quite optimistic. Many seem to be thinking: the recession of 2001 is over, and we only seem to get recessions about once every 10 years now, so there's no reason why the stock market should not be up. They are not thinking about stock market crashes as a possibility. But I've been advising people to diversify and not have too intense an exposure to the U.S. stock market. The market is vulnerable if there is some bad economic news.

LOUNGANI: What kind of news would cause another correction?

SHILLER: One kind of bad news that worries me is about the U.S. labor market. It has done poorly. We are down over two million jobs in the past three years and down nearly one million jobs from the end of the 2001 recession. Since World War II, the only other labor market contraction as protracted as this occurred around the time of the great recessions of 1980 and 1981-82. But back then people knew that the cause of the contraction was the Fed [Federal Reserve Board] policy. This time, the cause is less clear. Labor market fears can weigh on investors, destroying confidence. That's what happened in the 1930s. We could also get a burst of inflation, as we did in January when the consumer price index went up an annual rate of nearly 6 percent. If the Fed decides the increase is more than a onetime blip, it will react. Interest rates will go higher, and then the stock market won't look like such a good investment.

LOUNGANI: Could further corporate scandals also take a toll?

SHILLER: On that score I'm actually somewhat sanguine. The United States has done enough that U.S. investors at least have got some reassurance from it. [New York State Attorney General] Eliot Spitzer has been going after corporate crime as aggressively as Eliot Ness, the guy who went after the gangster Al Capone. Combine that with people like [Massachusetts Secretary of the Commonwealth] William Galvin and William Donaldson, Chair of the Securities and Exchange Commission [SEC], and it adds up to a lot of people who are really doing their jobs. The budget for the SEC has really been increased; for 2004, it was over $800 million, more than double what it was five years ago. And people can see what a price Martha Stewart paid for acting on a tip...