Complex financial products and lax regulation can create opportunities for corruption and bad faith dealings that destabilize the entire system. Employers often pay above-market wages to boost morale, productivity, and loyalty. Workers strongly resist nominal wage cuts, even when economic conditions might warrant them, due to perceptions of unfairness. Policies that restore confidence during animal spirits downturns can have outsized positive effects, while those that undermine confidence can exacerbate negative cycles. When confidence is high, spending and investment increase, which further boosts confidence in a positive feedback loop.
Book review: Animal Spirits by Akerlof and Shiller
This intellectual complacency—rooted in the long dominance of classical and later New Classical economics—led governments to relax safeguards built after the Great Depression. The authors open by revisiting the 2008 crisis, noting that policymakers, investors, and the public had embraced a belief that markets were self-correcting. These “animal spirits,” first described by John Maynard Keynes, shape macroeconomic outcomes as much as any technical variable.
Minority poverty persists due to complex socio-economic factors
In the book Animal Spirits, Nobel laureate George Akerlof and Robert Shiller argue that modern economies cannot be understood through classical models alone.
How does Animal Spirits explain the relationship between confidence and economic performance?
Decisions chosen by more than just rational actors wanting mutualeconomic benefits. This social amplification process is identified as the core of the irrational exuberance of economic hypes. There are times where confidence can abound and, with no reliable basis, go beyond the rational. This is explained in detail and very convincingly in the book, driven by a number of questions that have proven tricky for classical economic theory.
MoneyScience \ Financial Intelligence \ Books & Reviews
- Keynes wrote that such decisions “can only be taken as a result of animal spirits.”
- They repeatedly stress the need for decisive action targeted at restoring credit flows, and that the overall stimulus from the government needs to be much larger than would otherwise be the case due to very low levels of confidence about short and medium term economic prospects.
- Chapter 14 is a conclusion where the authors state that the cumulative evidence they have presented in the preceding chapters overwhelmingly shows that the neo classical view of the economy, which allows little or no role for animal spirits, is unreliable.
“Akerlof and Shiller remind us that emotional and intangible factors—such as confidence in institutions, illusions about the nature of money or a sense of being treated unfairly—can affect how people make decisions about borrowing, spending, saving and investing. Animal Spirits is an affectionate tribute to the man John Maynard Keynes whose ideas, unfashionable for the past 30 years, have resurged.”—Nature Read it and learn how leaders can channel animal spirits—the powerful forces of human psychology that are afoot in the world economy today. Animal Spirits explores how psychological factors influence economic decisions, challenging traditional assumptions of rational behavior. Understanding animal spirits is particularly crucial during economic crises when confidence, narratives, and non-rational factors play an outsized role. “It is necessary to incorporate animal spirits into macroeconomic theory in order to know how the economy really works.” Individual acts of corruption can have outsized effects on the broader economy by undermining confidence and freezing credit markets.
In an economic crisis, the most important power of a central bank is acting as a lender of last resort. However, this reasoning omits the fact that people can meet their transaction needs in other ways. The usual view assumes that people carry demand deposits to meet transaction needs. The story of the Internet, a variation of the story of a new era, fueled one of history’s biggest stock market bubbles.
Akerlof and Shiller provide a comprehensive and well-structured analysis of the subject, offering real-world examples and historical context to support their arguments. It involves stories and perceptions of fairness. Because they see society as unfair, working within it poses psychological challenges. Meanwhile, stories about the importance of homeownership to the progress of minority populations led political leaders to promote what became the subprime lending boom. The 1990s stock market bubble may have made Americans think they were astute investors. Stories of stock prices can feed or launch such confidence and excitement.
Animal spirits affect everything from consumer spending and business investment to financial market volatility and labor relations. Understanding these animal spirits is crucial for explaining economic fluctuations and developing effective policies. However, real-world behavior is often driven by emotions, intuitions, and social factors that defy strict economic logic.
Confidence is shown to be the basis of economic behavior. Why are financial prices and corporate investments so volatile? Furthermore, this very book seems to be one of the “must-reads” in the Obama administration. The book has been translated into more than 20 languages including German, Chinese, Dutch, Persian, Greek, Italian, Spanish, and French.
Traditional economic theory assumes people make purely rational, self-interested decisions. They also advocate for measures aimed at inspiring confidence, mitigating speculative excesses, and fostering stability in financial markets. Akerlof and Shiller argue that traditional economic models often fail to consider the effects of these factors, as classic economic theory centers on the premise that people act rationally and, thus, make perfectly rational decisions.
Fairness perceptions influence wage-setting and labor markets
In contrast, the efficiency wage theory says employers fear that people hired at lower wages may resent the perceived unfairness of their pay and, thus, undercut productivity. It says people could get jobs if they took less pay, just as anyone who wants to sell a house usually can – by lowering the price. The conventional explanation of unemployment doesn’t account for people who want to work but can’t find jobs. Monetary and fiscal measures need to be expanded credit to achieve their economic goals.
Book review – “Animal Spirits”, by George A. Akerlof and Robert J.Shiller
- This social amplification process is identified as the core of the irrational exuberance of economic hypes.
- Confidence is shown to be the basis of economic behavior.
- Robert J. Shiller, the best-selling author of Irrational Exuberance and The Subprime Solution, teaches economics at Yale University.
- Stock prices and other financial assets fluctuate far more than can be justified by changes in fundamental economic factors.
- Changes in confidence often outweigh changes in economic fundamentals in driving booms and busts.
- Chapter 1 the authors discuss confidence, which they say is the most important animal spirit to know about if one wishes to understand the economy.
An exception to the numerous glowing reviews the book received was a lengthy critique published in The New Republic by the Judge Richard Posner. The authors argue that the effects of animal spirits make a strong case for affirmative action. The authors show how effects of animal spirits refutes the monetarist theory that there is a natural rate of employment which it is not desirable to exceed.
In the 1960s, economists such as Paul Samuelson, assumed that workers (being subject to money illusion) would bargain for nominal rather than real wages. Irrational money illusion is an aspect of animal spirits. John Maynard Keynes said a rational calculation could not account for such economic decisions as opening a mine or building a factory or constructing an office building. Instead they explained economic events as the result of people pursuing their rational self-interest. They say conventional economic theory assigns too much weight to the role of reason in economic decision making, and too little to the role of irrational emotional and psychological factors. The authors are doubtless sympathetic to the case for “libertarian paternalism” in Nudge, by Richard Thaler and Cass Sunstein – another valuable book that explores the possibilities of “behavioural economics”.
Further reading
His collaborative work with Robert Shiller in “Animal Spirits” explores the role of human behavior in economic decision-making. He was awarded the Nobel Prize in Economics in 2001 for his work on markets with asymmetric information. While praised for its accessible writing and novel approach to macroeconomics, some readers found it lacking in practical solutions. Economic institutions and regulations should be designed with human psychology in mind to promote stability and prevent abuses. Addressing minority poverty requires going beyond traditional economic policies to address deeper social and psychological factors. The psychological drivers of real estate cycles make them difficult to manage through traditional monetary and regulatory tools alone.
Money illusion affects economic decision-making and policy
People tend to think that the value of moneyis static, which is the money illusion, for in practice money purchasesdifferent amounts of the same product over time. There are consequences to animal spirits,which leads to a role for government, to prevent the consequences fromescalating. Animal spirits arethe noneconomic motives of decision making. Animal spirits are thoughts and feelings of animatepeople. In turn, much of human motivationcomes from living through a story of our lives, a story that we tell ourselvesand that creates a framework for motivation.” – George A. Akerlof, and RobertJ.
The persistent effects of past discrimination create ongoing economic disadvantages for minority groups. “It appears that people had acquired a strong intuitive feeling that home prices everywhere can only go up.” “No one can even explain why these events rationally ought to have happened even after they have happened.” How saving decisions are presented (e.g., opt-in vs. opt-out retirement plans) can have dramatic effects on behavior.
However, some readers might point out that the book oversimplifies the complexities of economic behavior and lacks more details in the proposed policy solutions. The authors bring real-world examples and compelling arguments throughout the chapters, making the reading engaging and easily digestible. They defend the importance of understanding animal spirits when designing economic policies, calling for a holistic approach to policy making.
“The human mind is built to think in terms of narratives, ofsequences of events with an internal logic and dynamic that appear as a unifiedwhole. An anti-library are all the books which you have not read. The authors make the point that and where animal spirits matter, but do not give many hints to how they do. Each economic bubble has such a story of success, of a quasi-infinite growth of some economic sector. Furthermore, wages are seen to be fair only when they are slightly above the market clearing wage. As a consequence, wage contracts are not indexed for economic variability, or, if so, only in one direction, i.e., growth.
Leave a Reply