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Animal Spirits by George Akerlof and Robert Shiller: A Must-Read for Anyone Interested in the Economy and Global Capitalism (PDF)
Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism by George Akerlof and Robert Shiller
Have you ever wondered why people sometimes act irrationally in economic decisions? Why do they buy things they don't need, or sell things they do need? Why do they panic when the stock market crashes, or get euphoric when it booms? Why do they follow fads and trends, or stick to habits and traditions? Why do they trust or distrust strangers, or cooperate or compete with others?
Animal Spirits George Akerlof Pdf Download
If you have, then you are not alone. Economists have also been puzzled by these questions for a long time. They have tried to explain human behavior using rational models that assume people are always maximizing their self-interest and making optimal choices based on available information. However, these models often fail to capture the complexity and diversity of human psychology, especially in times of uncertainty and change.
This is where animal spirits come in. Animal spirits are the emotions and instincts that influence our economic decisions, sometimes overriding our rational calculations. They are not necessarily bad or good, but they can have powerful effects on the economy, both positive and negative. They can drive innovation and growth, but also cause instability and crises. They can foster cooperation and solidarity, but also generate conflict and inequality.
In this article, we will explore the concept of animal spirits, how they affect the economy, and why they matter for global capitalism. We will also discuss some of the policy implications of animal spirits, and how they can be harnessed or mitigated to achieve better economic outcomes. We will base our analysis on the book "Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism" by George Akerlof and Robert Shiller, two Nobel laureates in economics who have pioneered the field of behavioral economics.
Introduction
What are animal spirits?
The term "animal spirits" was coined by John Maynard Keynes, one of the most influential economists of the 20th century. In his seminal work "The General Theory of Employment, Interest and Money", published in 1936, Keynes argued that the level of economic activity depends not only on objective factors such as income, prices, interest rates, and technology, but also on subjective factors such as expectations, confidence, optimism, pessimism, and mood.
Keynes wrote: "Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations...Most...of our decisions to do something positive...can only be taken as the result of animal spirits - a spontaneous urge to action rather than inaction."
Keynes used the term "animal spirits" to capture the idea that human behavior is not always rational or predictable, but rather influenced by psychological factors that are often hard to measure or control. He recognized that these factors play a crucial role in determining the level of aggregate demand in the economy, which in turn affects output, employment, income, and prices.
Akerlof and Shiller build on Keynes's insight and identify five main categories of animal spirits that affect economic decisions: confidence, fairness, corruption and bad faith, money illusion, and stories. They define animal spirits as "the thought patterns that animate people's ideas and feelings, their animal spirits. These are the impulses that drive human behavior in ways that may not be rational but are nonetheless powerful."
Why do animal spirits matter for the economy?
Animal spirits matter for the economy because they can have significant effects on the behavior of consumers, investors, workers, firms, and governments. They can affect how much people spend or save, how much they invest or borrow, how much they work or leisure, how much they produce or consume, and how much they tax or spend.
For example, confidence is a key animal spirit that affects economic activity. Confidence is the degree of trust or belief that people have in the future prospects of the economy, their own situation, and others' actions. When people are confident, they tend to spend more, invest more, work more, and produce more. This creates a positive feedback loop that stimulates economic growth and prosperity. On the other hand, when people are pessimistic, they tend to hoard money, cut back on spending, postpone investment, reduce work effort, and produce less. This creates a negative feedback loop that depresses economic activity and leads to recession and unemployment.
Another example is fairness, which is the sense of justice or equity that people have regarding economic transactions and outcomes. Fairness affects how people behave in markets, workplaces, and society. When people perceive that they are treated fairly, they tend to cooperate more, work harder, pay taxes more willingly, and obey laws more faithfully. This enhances social cohesion and economic efficiency. On the other hand, when people perceive that they are treated unfairly, they tend to defect more, shirk more, evade taxes more aggressively, and break laws more frequently. This erodes social trust and economic performance.
How do animal spirits affect global capitalism?
Animal spirits affect global capitalism in several ways. First, they can create booms and busts in financial markets and the real economy. Financial markets are especially prone to animal spirits because they involve high levels of uncertainty, speculation, leverage, and herd behavior. When investors are optimistic about future returns, they bid up asset prices beyond their fundamental values. This creates bubbles that eventually burst when reality catches up with expectations. When investors are pessimistic about future losses, they sell off assets at fire-sale prices. This creates crashes that spread contagion across markets and countries.
The real economy is also subject to animal spirits because it depends on the level of aggregate demand generated by consumers and firms. When consumers and firms are confident about future income and profits, they increase their spending and investment. This boosts aggregate demand and output. When consumers and firms are fearful about future losses and bankruptcies, they reduce their spending and investment. This lowers aggregate demand and output.
Second, animal spirits can create social and political challenges for global capitalism. Global capitalism is a system of economic integration and interdependence among countries based on free trade, free capital flows, free migration, and free competition. It has brought many benefits to the world in terms of growth, innovation, efficiency, diversity, and choice. However, it has also created many costs in terms of inequality, instability, insecurity, exploitation, and environmental degradation.
Animal spirits can amplify these costs by generating resentment and resistance among those who feel left behind or harmed by global capitalism. For example, fairness can trigger social movements and protests against perceived injustices or abuses by corporations or governments. Corruption can undermine the legitimacy and accountability of institutions and leaders who are supposed to serve the public interest. Stories can shape the narratives and identities of groups who seek to challenge or defend the status quo.
The Role of Animal Spirits in Economic Crises
The Great Depression
The Great Depression was the most severe economic crisis of the 20th century. It lasted from 1929 to 1939 and affected almost every country in the world. It was characterized by a sharp decline in output, employment, income, trade, and prices.
The Great Depression was largely caused by a collapse of confidence in the economy following the stock market crash of 1929. The crash triggered a wave of panic selling that wiped out billions of dollars of wealth and damaged the balance sheets of banks, firms, and households. This led to a contraction of credit, spending, and investment, which reduced aggregate demand and output. The contraction was amplified by a series of policy mistakes by governments and central banks that failed to provide adequate fiscal and monetary stimulus or international coordination. Instead, they pursued deflationary policies such as raising interest rates, cutting public spending, raising taxes, and imposing trade barriers. These policies deepened the depression and prolonged the recovery.
The Global Financial Crisis
The Global Financial Crisis was the most severe economic crisis of the 21st century so far. It started in 2007 and lasted until 2009, but its effects are still felt today. It affected almost every country in the world, but especially the United States and Europe. It was characterized by a collapse of the global banking system, a sharp decline in output, employment, income, trade, and prices, and a rise in public debt and deficits.
The Global Financial Crisis was largely caused by a burst of confidence in the financial markets following a boom in housing prices and mortgage lending. The boom was fueled by animal spirits such as optimism, greed, and herd behavior among investors, lenders, borrowers, and regulators. They believed that housing prices would always rise and that financial innovations such as securitization, derivatives, and ratings would reduce risk and increase returns. They ignored or underestimated the possibility of a downturn or a default.
When the housing bubble burst in 2007, it triggered a wave of panic selling that wiped out trillions of dollars of wealth and damaged the balance sheets of banks, firms, and households. This led to a freeze of credit, spending, and investment, which reduced aggregate demand and output. The freeze was amplified by a series of policy failures by governments and central banks that failed to provide adequate fiscal and monetary stimulus or international coordination. Instead, they pursued austerity policies such as cutting public spending, raising taxes, and imposing fiscal rules. These policies deepened the recession and prolonged the recovery.
The Covid-19 Pandemic
The Covid-19 Pandemic is the most severe economic crisis of the current decade. It started in 2020 and is still ongoing. It has affected almost every country in the world, but especially developing and emerging economies. It is characterized by a global health emergency, a sharp decline in output, employment, income, trade, and prices, and a rise in poverty and inequality.
The Covid-19 Pandemic was largely caused by a shock to confidence in the economy following the outbreak of a novel coronavirus that originated in China and spread rapidly around the world. The virus caused a high level of morbidity and mortality among infected people and forced governments to impose lockdowns and social distancing measures to contain its spread. These measures disrupted economic activity and reduced aggregate demand and output. The disruption was amplified by animal spirits such as fear, uncertainty, and pessimism among consumers, investors, workers, firms, and governments. They reduced their spending, investment, work effort, production, and cooperation.
The Covid-19 Pandemic also exposed the weaknesses and vulnerabilities of the global economic system that had been accumulated over decades of neoliberal policies that favored market forces over public goods. These policies eroded the capacity and resilience of public health systems, social protection systems, environmental systems, and international institutions to cope with the crisis. They also increased the inequality and fragility of economic outcomes and opportunities for different groups and regions.
The Policy Implications of Animal Spirits
How to restore confidence and trust in the economy
One of the main policy implications of animal spirits is that governments need to restore confidence and trust in the economy to overcome economic crises and achieve sustainable growth. Confidence and trust are essential for economic activity because they affect the expectations and behavior of consumers, investors, workers, firms, and governments. They also affect the credibility and effectiveness of policies and institutions.
To restore confidence and trust in the economy, governments need to adopt policies that are timely, targeted, transparent, and coordinated. They need to provide fiscal stimulus to boost aggregate demand and output, monetary stimulus to lower interest rates and increase liquidity, and financial stimulus to stabilize and recapitalize the banking system. They also need to provide social stimulus to protect and empower the most vulnerable groups and sectors, such as health care workers, essential workers, low-income households, small businesses, and informal workers.
In addition, governments need to adopt policies that are credible, consistent, accountable, and participatory. They need to communicate clearly and honestly with the public about the nature and severity of the crisis, the objectives and rationale of their policies, the expected outcomes and risks of their actions, and the trade-offs and costs of their choices. They also need to consult widely and inclusively with stakeholders and experts about the design and implementation of their policies, the evaluation and feedback of their results, and the adaptation and improvement of their strategies.
How to regulate financial markets and institutions
Another policy implication of animal spirits is that governments need to regulate financial markets and institutions to prevent economic crises and promote financial stability. Financial markets and institutions are prone to animal spirits because they involve high levels of uncertainty, speculation, leverage, and herd behavior. They can create booms and busts that have spillover effects on the real economy and the society.
To regulate financial markets and institutions, governments need to adopt policies that are preventive, corrective, and adaptive. They need to prevent excessive risk-taking and speculation by imposing prudential rules and standards on capital, liquidity, leverage, transparency, and governance. They need to correct market failures and distortions by enforcing antitrust laws, consumer protection laws, tax laws, and environmental laws. They need to adapt to changing conditions and challenges by monitoring financial innovations, systemic risks, and emerging threats.
In addition, governments need to adopt policies that are comprehensive, coherent, and cooperative. They need to cover all types of financial actors, activities, instruments, and markets, including banks, non-bank financial intermediaries, shadow banking entities, hedge funds, private equity funds, derivatives markets, crypto-currencies, and fintech platforms. They need to coordinate their policies across different sectors, levels, and jurisdictions, including monetary policy, fiscal policy, macroprudential policy, microprudential policy, and international policy. They need to cooperate with other countries and regions to harmonize their regulations and standards, to share information and data, and to resolve disputes and conflicts.
How to promote social justice and environmental sustainability
A third policy implication of animal spirits is that governments need to promote social justice and environmental sustainability to enhance economic performance and human well-being. Social justice and environmental sustainability are not only moral imperatives but also economic necessities. They can improve the quality and quantity of human capital, natural capital, and social capital, which are essential for economic growth and development.
To promote social justice and environmental sustainability, governments need to adopt policies that are redistributive, protective, and transformative. They need to redistribute income and wealth from the rich to the poor, from the powerful to the weak, from the privileged to the marginalized, and from the present to the future. They need to protect the rights and interests of workers, consumers, citizens, minorities, women, children, and animals. They need to transform the structures and systems that generate inequality, instability, insecurity, exploitation, and degradation.
In addition, governments need to adopt policies that are integrative, inclusive, and innovative. They need to integrate social and environmental objectives with economic objectives, such as reducing poverty, improving health, enhancing education, preserving biodiversity, combating climate change, and advancing democracy. They need to include all stakeholders and beneficiaries in the decision-making process and in the distribution of benefits. They need to innovate new ways of producing, consuming, exchanging, and living that are more efficient, equitable, resilient, and sustainable.
Conclusion
Summary of the main points
In this article, we have explored the concept of animal spirits, how they affect the economy, and why they matter for global capitalism. We have also discussed some of the policy implications of animal spirits, and how they can be harnessed or mitigated to achieve better economic outcomes. Here is a summary of the main points:
Animal spirits are the emotions and instincts that influence our economic decisions, sometimes overriding our rational calculations.
Animal spirits can have significant effects on the behavior of consumers, investors, workers, firms, and governments. They can affect how much people spend or save, how much they invest or borrow, how much they work or leisure, how much they produce or consume, and how much they tax or spend.
Animal spirits can create booms and busts in financial markets and the real economy. They can drive innovation and growth, but also cause instability and crises. They can foster cooperation and solidarity, but also generate conflict and inequality.
Animal spirits can create social and political challenges for global capitalism. They can trigger resentment and resistance among those who feel left behind or harmed by global capitalism. They can also expose the weaknesses and vulnerabilities of the global economic system that has been eroded by neoliberal policies.
sustainability.
Recommendations for further reading
If you are interested in learning more about animal spirits and their role in the economy, we recommend the following books and articles:
Akerlof, G. and Shiller, R. (2009). Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism. Princeton University Press. This is the main source of this article and a comprehensive and accessible introduction to the concept of animal spirits and their implications for economic theory and policy.
Keynes, J.M. (1936). The General Theory of Employment, Interest and Money. Macmillan. This is the classic work by Keynes that introduced the term "animal spirits" and revolutionized macroeconomics by emphasizing the role of aggregate demand and expectations in determining economic activity.
Shiller, R. (2019). Narrative Economics: How Stories Go Viral and Drive Major Economic Events. Princeton University Press. This is a recent book by Shiller that explores how stories and narratives shape economic behavior and outcomes, and how they can be measur