Book review: Animal Spirits by Akerlof and Shiller

Traditional economic theory centers on the premise that people make perfectly rational decisions. Despite many attempts, not every variable that goes into our decision-making process can be easily quantified, weighted, and stuffed into a formula. As any non-economist knows psychology — and its hard to measure variables — plays a large role in how people make decisions. Well before John Maynard Keynes stressed the reliance of capitalism on investors’ “animal spirits,” these vernacular vitalists established an American religion of embodied mind that also suited the needs of the marketplace. Today, scientists are rediscovering the best features of the vitalist tradition—permitting us to reclaim the role of chance and spontaneity in the conduct of our lives and our understanding of the cosmos.

Most historical events are driven by slow pressure from millions of sources, with no clear “Great Man” to be the hero or the villain. Reality is unrealistic, and sadly, the good guys don’t always win. Akerlof and Shiller are notorious advocates of Keynesian thought. Not because of some underhanded desire to allow government to intrude in our lives, but because Keynes believed in taking account of the qualitative and intangible aspects of human behavior. Admittedly, they do refer to some of Milton Friedman’s conclusions as naive. This book provides a more convincing and deeper explanation of the recent credit crisis than any I have read.

It is written in a very readable style, and uses hardly any math; but it marks a paradigm shift in macroeconomic theory. Instead of assuming that workers and capitalists are rational, let’s study how they actually think and behave. Part of the reason why I found this book quite so interesting was because I’ve read lots of books about behavioural economics over the years, but they are much more interested in psychology than they are in economics. For instance, a book that I am constantly recommending and even buying for people is ‘Predictably https://forexarena.net/ Irrational’ – and it proudly refers to itself as being one set in behavioural economics, but really, you sort of have to squint to see the connection to economics most of the time. Now, don’t get me wrong – I’ve really enjoyed those books, but what this one does is to place behavioural economics squarely in the realm of economics. This is also, effectively, a re-introduction to Keynesian economics, a view of economics that went out of favour with Milton Freedman and Ronald Reagan – the consequences of which we are living with today.

Akerlof and Shiller sketch out a plausible qualitative account of what happened in the 2008 crash and the Second Depression, and offer some basic suggestions on how we might fix the problem… But much of what they say is vague, and none of it offers sharp, quantitative predictions. Animal Spirits is, in all but name, an introductory textbook on cognitive macroeconomics.

John Maynard Keynes Economic Analysis

It cleverly contrasts the tensions between two couples—one newly minted, the other long-standing—who share a vacation cottage. But a lost puppy becomes the too-obvious metaphor for domestic bliss, and the resolution feels pat. In “Indian Land,” “the fragility of nature” more successfully reflects human fragility as a happily married woman leaves her husband in Rome to aid an ex-lover having a nervous breakdown in New Mexico .

One of the things about economics is that it seems impossible to predict the future, which is annoying, since it does seem that virtually the whole of economics is set up to do exactly that. One of the main reasons for this feeling of mine is that ‘this is a special time and place and that is why the bubble will not burst this time’ is exactly the logic that has driven EVERY bubble. That every bubble that has ever existed has eventually popped is not proof that this one will have to pop, of course, but I still wouldn’t ‘bet my house on it’ so to speak.

The five key animal spirits are treated here, each assigned their own chapter. Animal Spirits is an important—maybe even a decisive—contribution at a difficult juncture in macroeconomic theory. Akerlof, a Nobel laureate, and Shiller, a good bet to become one, are prominent mainstream economists. They don’t deviate easily from orthodox theory, with its allegiance to the proposition that people are essentially rational, well informed and unemotional in the numerous transactions that shape the economy. But in “Animal Spirits,” they have deviated — and they have done so just as mainstream theory self-destructs.

One of the most identifiable ‘animal spirits’ presented is stories. The authors illustrate the role that stories play in the economy; these stories are closely linked to aggregate confidence in an economy. Take, for example, the pervasiveness of ‘New Era’ stories, such as those that surrounded the internet. Stories have a tendency to spread like viruses through populations, and as such one must consider their effect on the economy.

I ended up abandoning this book after the first few chapters. I agree with much of what Akerlof asserts, but the author’s continual tone of “the other side is a bunch of idiots” just got tiring. The worlds of psychology and economics both deal with the volatile world of human judgments and are therefore notoriously inexact sciences. I prefer authors who approach both of these topics with a collegial spirit and the humility to understand there is much work still to be done.

They have interesting psychological ideas, such as the importance of a national “story”, really a paradigm, that drives herd mentality and, thus, irrational behavior. Examples would be the recent, ill-fated real estate mania in the United States or the malaise on the part of business operators in FDR’s second term who felt they were under attack. This was an interesting book addressing economic events (depressions, stock market and real estate booms and busts, etc.) without “economics” jargon. The primary theme of the book attacks the basic economics premise that people primarily make rationale decisions in their economic interests, instead of often acting irrationally or in response to perceptions of fairness, corruption, etc. This seems like a common sense approach, but was apparently revolutionary for economists.

Chapter 5 is about the importance of stories in determining behaviour. Such as the repeatedly told story that house prices will always rise, which caused many additional people to invest in housing following the dot com bust of 2000. Chapter 4 presents evidence that, in contrast to monetarist theory, many people are at least partially under the money illusion, the tendency for people to ignore the effects of inflation. Workers for example will forgo a pay rise even when prices are rising, if they know that their firm is facing challenging conditions—but they are much less willing to accept a pay cut even when prices are falling. Both men are old hands at prodding their fellow economists into recognizing exceptions to mainstream theory.

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I find neoclassical microeconomics mind-numbingly boring; cognitive microeconomics is more interesting—and more valid—but it still lacks the glamor of large-scale impact that macroeconomics promises. If we want to live by Keynes’s “the world is ruled by little else”, it is in macroeconomics that we will do so. The theory of animal spirits, which is underpinned by fundamental uncertainty, has been developed heavily by Post Keynesian economists and yet this isn’t mentioned once in the book. There is a fleeting mention of Knight’s thoughts on uncertainty vs risk, but no theory of animal spirits can claim to be rigorous without properly laying out the insights of scholars on uncertainty. What drives bubbles to pop has much less to do with the objective conditions that make looking at bubbles encourage you to want to put your hands over your eyes. It is much more about when people ‘feel it in their waters’ that the rout is on.

• However, there are just too many unquantifiable variables – feelings, emotions, intuition, and confidence– to accurately incorporate all available information into a simple neat equation.
• Akerlof and Shiller intend their book as an obstacle to that ever happening.
• Only the wise hand of government on economic the tiller can save us.
• Instead, it’s essentially an extended overview of methodological debates within the economics profession.

You are not the “rational man” that economists think you are, none of us are. And if you want to understand why they think that way, and how it screwed up our economy this book will help. These factors have always been present in human actions but economists never paid them mind, animal spirits as human uncertainties severally complicate economic models of prediction and are inconvenient for laissez-faire supporters. In the end, their conclusions are modern and well-thought out. Behavioral and Experimental economics appears to be the next evolution in Economic theory.

George Akerlof won the Nobel Prize in economics in 2001, and Robert Shiller has long been an astute observer of the madness of crowds. Instead of a penetrating analysis which yields up new findings, the reader is left with conclusions that are obvious to anyone familiar with the way economic decisions are made in the real world. Akerlof and Shiller remind me of George Soros, who, similarly, exults in destroying a straw-man which only the most extreme worshiper of untrammeled free-market capitalism approximates. Look around you, George A. Akerlof and Robert J. Shiller say. The second coming of the Great Depression is, like the original, a direct result of animal spirits.

They seem to imply that, given more study, “animal spirits” could be understood and incorporated into economic formulas and models. This idea seems to fly in the face of the “illogical nature of animal spirits” thesis that the book spends so much effort explaining. Like Keynes, Akerlof and Shiller know that managing these animal spirits requires the steady hand of government–simply allowing markets to work won’t do it. Like Keynes, Akerlof and Shiller know that managing these animal spirits requires the steady hand of government—simply allowing markets to work won’t do it. First, it was originally written to be used as a textbook in upper year economics courses; accordingly, it skims over many topics, assuming the reader has prior knowledge of economics. Also, as a textbook, it is not the most thrilling read at times; the discussion of the Phillips Curve in the chapter on money illusion is a case-in-point.

About This Book

As the authors point out, if people are willing to pay for snake oil , the economy will produce snake oil. This is especially relevant in the financial markets; the authors illustrate how this contributed to the creation of numerous shoddy financial products over the past decade. The authors also note that corruption in financial markets can lead individuals to seek alternative investments.

People are crazy, so the authors say, their behaviour is irrational and, in the Keynesian way, this can cause economies to crash and stay crashed. Only the wise hand of government on economic the tiller can save us. Animal spirits relate to some of the predictably irrational ways humans set about engaging with the economy. For example, the authors make the point that people want to believe that their wages are ‘fair’.

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The title of the book isn’t well justified in the text, and each usage of the term ‘animal spirits’ is clunky- simply calling some undesired effect to be due to it and therefore the author’s solution is the only one that will work isn’t very convincing. It would lose marketability but I wish I would hear an economist talk about linearization- various economics theories of the past are actually linearized approximations of actual behaviour, but behaviour outside of the valid linear range is either undefined or bears more research. Insofar as “Animal Spirits” takes the reader on a guided tour through some of the financial cataclysms of the 20th century, it is useful as a historical narrative.

Still, updating the old notion that the Earp myth is the American Iliad, the author is at his best when he delineates those fraught spasms of violence. “It is never a good sign for law-abiding citizens,” he writes at one high point, “to see Johnny Ringo rush into town, both him and his horse all in a lather.” Indeed not, even if Ringo wound up killing himself and law-abiding Tombstone faded into obscurity when the silver played out. Unchecked, they drive the economy into misbegotten booms and disastrous busts.

Such an idea is so stupid it is surprising it was ever accepted as the basis of any subject that seeks to describe itself as a ‘science’. The idea that unemployment is working people taking a kind of holiday is equally laughable, even if it does mean that believing such allows right-wing types can feel justified in cutting unemployment benefits from people so as to give them an incentive to find a job. It is a powerful, cogent, and convincing call for a fundamental reevaluation of basic economic principles. It presents a refreshingly new understanding of important economic phenomena that standard economic theory has been unable to explain convincingly. Animal Spirits should help set in motion an intellectual revolution that will change the way we think about economic depressions, unemployment, poverty, financial crises, real estate swings, and much more.