Animal Spirits

George A. Akerlof & Robert J. Shiller, “Animal Spirits” (How Human Psychology Drives The Economy, And Why It Matters For Global Capitalism), Princeton Univ Press, 2009, 198 Pages

George A. Akerlof is a Professor of Economics at the University of California, Berkeley. He was awarded the 2001 Nobel Prize in economics. Robert J. Shiller is the best-selling author of Irrational Exuberance and The Subprime Solution (both Princeton). He is a Professor of Economics at Yale University.

These two well known economists challenge the orthodox economic thinking that got us into our current mess. Orthodox theory maintains that people are essentially rational, well informed and unemotional in the numerous transactions that shape the economy. Thus, with such a rational framework, little regulation is required or desired.

The authors submit that orthodox economic thinking left out the behavioral aspects of human behavior (what they and Keynes call “animal spirits”). The most pervasive effects of these animal spirits in contemporary economic life involve items such as confidence, fear, bad faith, corruption, a concern for fairness, and the stories we tell ourselves about our economic fortune (such as: real estate prices always go up & if I don’t buy now, I will never be able to afford to buy). Recognition of the behavioral influences on economics is necessary to formulate economic policies, and going forward will require government regulation--simply allowing markets to work won't do it. Reganomics is dead.

My Notes:

Pg. 14: The most basic element of Keynesian economic theory is its notion of the multiplier, which works as follows. Any initial government stimulus puts money into people’s hands, which they then spend. Te initial government stimulus is the first round. Each dollar spent by the government ultimately becomes income to tome people, and, once it has been put into their hands, they spend some fraction of it. That fraction is called the marginal propensity to consume (MPC. Thus the initial increase of expenditures feeds back into a second round of expenditures, made by people, not the government. The then feeds back again into income for yet more people, in an amount equal to the MPC dollars, and so forth. The sum of all these rounds is not infinite; it is in fact equal to 1/(1-MPC), a quantity that is called the Keynesian multiplier. Of course, this can work in reverse. The multiplier theory explained that a small dip in expenditure could have greatly magnified effects. If there were a small but substantial decline in consumption expenditures because people overreacted in fear to a stock market crash, such as the one of 1929, then this would act like a negative government stimulus.

Pg. 67: In contrast to the U.S. depression of the 1890s, the Great Depression of the 1930s raged on both sides of the Atlantic. IN the U.S. unemployment rose above 10% in November 1930 and peaked at 25.6% in May 1933. In the United Kingdom the unemployment rate rose above 10% in the month of the stock market crash of 1929, peaked at 26.6% in January 1931, and did not fall below 10% until April 1937. In Germany the unemployment rate rose above 10 in October 1929, peaked at 33.7% in December 1930, and did not fall below 10% until June 1935. Australia was much the same.

Pg. 86: This recession is different. It is not just due to low demand. Nor is it primarily due to high energy prices, although oil prices were especially high in the summer of 2008. The overwhelming threat to the current economy is the credit crunch. It will difficult and perhaps even impossible to achieve the goal of full employment if credit falls considerably below its normal levels.

Pg. 131: The real value of the U.S. stock market rose over fivefold between 1920 and 1929. It then came all the way back down between 1929 and 1932. The real value of the stock market doubled between 1954 and 1973. Then the market came all the way back down. It then lost half of its real value between 1973 and 1974. The real value of the stock market rose almost eightfold between 1982 and 2000. Then it lost half of its value between 2000 and 2008. The question is not just how to forecast these events before they occur. No one can even explain why these events rationally ought to have happened even after they have happened.

Pg. 168: It is necessary to incorporate animal spirits into macroeconomic theory in order to know how the economy really works. In this respect the macroeconomics of the past thirty years has gone in the wrong direction. In their attempts to clean up macroeconomics and make it more scientific, the standard macroeconomists have imposed research structure and discipline focusing on how the economy would behave if people had only economic motives and if they were also fully rational.

Pg. 174: From time to time it appears that democracies undergo great shifts in their stories of who people are and who they should be. Associated with these shifts are changes in the stories about how the economy works. We might view the U.S. as having undergone six such major shifts: at the time of the Revolution, after the elections of Andrew Jackson ad later of Abraham Lincoln, at the end of Reconstruction, during the Great Depression, and after the election of Ronald Regan.
After Regan’s election the explanation of how the economy worked turned to the conservative image (the invisible hand). This shift also occurred in Great Britain, and other countries, from India to China to Canada.