Acknowledging Our 'Animal Spirits'

The new book from George Akerlof and Robert Shiller, Animal Spirits, has been getting a lot of press of late, and quite rightly: it's really good. It's not only very readable; it also offers a compelling vision of a very different type of macroeconomics -- one where behavioral considerations are front and center, rather than simply providing what Clive Crook calls "ad hoc modifications" to the standard, ridiculously oversimplified and unrealistic, model.

Conor Clark has an interview with Akerlof, in which Akerlof thinks about moving away from the idea of countercyclical fiscal and monetary policy, and moving towards a more broader notion:

One of the roles of the government is to offset the animal spirits. So that when animal spirits are high -- and people are too trusting and they engage in investment projects that they shouldn't engage in -- one of the roles of the government is to offset them. More should have been done to curb the over-exuberance and excesses in the housing market. That's one.
But at the same time, if the confidence then dries up, it's the role of the government to stimulate the demand that's fallen because of the lost confidence.

This is much bigger than the idea that it's the job of central bankers to identify bubbles and gently deflate them before they get too big. For one thing, it draws no clear distinction between fiscal policy and monetary policy; instead, it looks at the animal spirits of the country as a whole, and tries to keep them on a relatively even keel. That has very little to do with targeting inflation, and is only partly concerned with targeting full employment: it's a distinct notion, made up of different parts, and one which this book goes a long way to addressing in a rigorous manner.

David Merkel has a great post on how this kind of thinking can reveal problems with investment strategies, or the lack thereof:

Because people don't like to think hard, they don't optimize, as the neoclassical economists posit. Instead, they choose solutions that they deem to be "pretty good," and stop their searching. Searching is a cost. But neoclassical economists insist that consumers maximize utility and producers maximize profit anyway. Why?

On an individual level, it's really important to examine one's own biases as pitilessly as possible; on a national level, I see the job of entities such as Paul Volcker's Economic Recovery Advisory Board to be one of gauging the level of animal spirits across the country -- something that all central bankers do by nature, which is one reason that Volcker is a good choice to head it.

I should also mention that if you're into all this stuff, and you're looking to read up on more of it, don't necessarily stop at Nudge. There's also Free Market Madness, by Peter Ubel, which fits nicely in between the policy-oriented empirical micro-experiments of Thaler and Sunstein, on the one hand, and the big-picture architecture of Akerlof and Shiller, on the other.

Also, Ubel is a physician, which makes his book a refreshing change from those of the economists. But if you only read one book on this subject, make it Animal Spirits.

Comments

[Amitabha Mu...:]

The government should be small as is evident from so many years of socialist rules in Soviet Union. As is being wisely said absence of planning and control is the best planning. If we see the rise of gigantic companies from scratch we would better realize it. But unfortunately most of the times elected representatives big or small who just get there by the then opinion of the local population do not have the necessary technical expertise to deliver. Everybody in America is blaming now the big bankers but then those were the people who gave unprecedented continuous affluence to the American population. Their only mistake was that they pushed the business of banking to the highest limit attainable. So instead of being jumpy we should wait as this financial storm will also pass.

Feb 21 09:23 AM

[woollyB:]

It is laughable to think that government can "manage" the animal spirits. Government is "of the herd, by the herd, for the herd." Politicians who think differently than the current mentality cannot and will not be elected.

Feb 21 09:34 AM

[nym:]

Yes, government in US includes Congress and administrations as bad as GW's. How about the "enlightened self-interest" of the well educated (not Yale, apparently) portion of the citizens?

Feb 21 09:39 AM

[abdul raab:]

Sorry, the church isn't at fault in this mess. If anything, had people heeded the church's commandments to not live for the temporal pleasures of the world but instead spending time doing good, unselfish deeds, we might all be much, much better off

Feb 21 10:06 AM

[Bigred:]

1) The church IS at fault in that they get away with not paying taxes on their bountiful business operations. ONLY the physical church itself should not pay taxes, and ALL the rest of its properties/businesses should, because we're losing billions (per year) on the mega buy ups of land, or haven't you noticed how much church's own of New York alone! (save billions per year)
2) cut government by 10% (save billions per year)
3) flat tax and reduce IRS by 75% (save billions per year)
4) penalize corps for going outside US for production (save billions per year, not to mention a few million jobs, and Detroit wouldn't become a ghost town)
5) maybe those that run for office should be required to have run a successful business so that they at least know what they're talking about when they run THE largest company on the planet (the U.S.A.) and not be a professional con like lawyers are trained to be

Feb 21 10:30 AM

[user344210:]

I read this yesterday and think it's a well-thought out critique of the whole idea of "stimulus", including addressing some of the behavioral issues.

www.theweek.com/articl...

Money quote re: animal spirits:

"There's a chance that some of the infrastructure spending will do the job of creating more work for earth-moving equipment and construction workers, Phelps noted. "I said, 'a chance'," he continued. "Now, there's also a chance that the perceived increase in the role of government of this sort will have some unanticipated effects on the animal spirits of entrepreneurs. These projects may stand as a sort of symbol of the weakening of the private sector."

Feb 21 10:41 AM

[austrian63:]

Clark shows his economic illiteracy when he states that " One of the government's roles is to offset the animal spirits." First, the Keynesian notion of animal spirits sounds really neat and philosophically deep at first blush but has no meaning at all. Has any one ever defined it? Second, if the government's role is to "offset animal spirits" why was it also the government's role to create the boom in the first place with artificially low interest rates and expand the money supply via bank credit expansion, et.al that led to the bust?

His statement shows a total lack of understanding of the role of the Federal Reserve System and our fractional reserve banking system. It was the government that lowered interest rates and pushed ever more credit out to the American consumer and businesses through the banking system via Fed policy - thank you Mr. Greenspan - free market believer - NOT.

The idea that central bankers should identify bubbles and gently deflate them also makes no sense. Central bankers inflate/create the bubbles in the first place via growth of the money supply. This is analogous to the old saying of the fox guarding the hen house.

I want a gig where I can create a problem or crisis and then ride in on a white horse and claim to be all knowing (pretense of knowledge) and save the day and get paid a nice salary to boot! Oh, my solutions will not work but I can blame this on those rascally "animal spirits" of the chaotic free market.

Feb 21 11:17 AM

[CLH:]

What is the govt.? Its us. The people that run the govt. are just as greedy as we are and only care about themselves as we do. Rediculous book.

Feb 21 11:37 AM

[bosun.j:]

In theory you are correct when you say we are the government. Next time you are renewing your license try telling the rude nasty hateful worker that you're her boss, suggest she modify her attitude and see how far it gets you!




On Feb 21 11:37 AM CLH wrote:

> What is the govt.? Its us. The people that run the govt. are just
> as greedy as we are and only care about themselves as we do. Rediculous
> book.

Feb 21 11:53 AM

[JohnL:]

To austrian63's point, I think the "animal spirits" would have been a lot more subdued if the banking system wasn't throwing easy money around one moment and then jacking up interest rates and constraining credit the next. I did not read the book either, but the review makes no mention of the role played by the credit cycle -- a phenomenon caused by that same government which is now supposed to be the solution. Does that make sense?

Feb 21 12:28 PM

[CJJ:]

I think what the book review here and the book are trying to point out is your stupid macro and micro econ books, your mathematical models, etc...don't take into account the general will and feeling of the people.

The internet is a huge game changer. The velocity of news is a huge game changer. In 5 minutes anyone in the modernized world can get the latest news. For the last year that news has been terrible.

Add on the fact the media is now in the business of opinion and the most grabbing headlines. 6 months ago most media was tepid in their coverage of the economic crisis. They were still optimistic...Boom...No... they mention depression daily as if it is a certainty. They exploit any rumor about any large company they can to get people worried and if it ends up being false they say "Don't shoot the messenger".

I don't like the term "animal spirits"...but if you discount people's will in all of this you are foolish. People aren't spending because they've been scared crapless about it from the daily bombardment in media and the internet. If gas prices go way up again get ready for this thing to get a whole lot worse because gas prices are synonymous with people's feeling of safety.

So this whole thing is way beyond Keynes or Austrian or whatever economic model you want to try to jam this all into. You may be able to prove markets are rational and good, but you can't deny that the people in them are irrational, greedy, and out for #1 over everyone else...Perhaps that's what the books trying to explain.

A few points:
-People comparing Governments of today to let's say the Government of the US in the late 1700s, early 1800s is ridiculous. As a comment earlier pointed out, there are too many people today to effectively govern. Smaller, bigger, more, less...it doesn't matter. Also we're looking at a basically unadded to Constitution after 200+ years. If you want to know what would outrage the Founding
Fathers most about Government, you can start right there with that fact. There are umpteen million ideas on every issue. Anything government does is immediately rejected right now. Its a no win propostion every time.
-Saying all big government is bad is obviously wrong as some commentors posted. You need quality government and you need a citizen base behind the government.
-I'll leave religion out of this but come on, really, don't say if people were more(or less) religious this crisis may not have happened. Its a ridiculous statement.

Feb 21 12:59 PM

[dw57:]

not true. they just did. again. they caused what we call the great depression. and they have done it again


On Feb 21 01:34 AM Rob Viglione wrote:

> The goal of macroeconomics is to rationalize central body decision-making.
> Given its grandiose intentions and mediocre performance, it would
> be wise to question this new "role of government."
>
> Governments have done the most harm to societies and economies throughout
> history-no private entity can claim such extravagant carnage.

Feb 21 02:12 PM

[EEB:]

I completely reject the notion that viable and flourishing societies exist without government. Could you please provide some examples? Usually, I think of anarchy as quite chaotic, and the life therein tends to be not very pleasant. I think that there is strong historical evidence for this view starting with Thucydides.

Our choice is not between horrible government and no government. That is a false dilemma. However, this does not mean that there aren't good and bad governments. I suggest that we search for ideas about what good government would look like, instead of repeating the naive view that the elimination of all government would lead to a flourishing society.


On Feb 21 01:34 AM Rob Viglione wrote:

> The goal of macroeconomics is to rationalize central body decision-making.
> Given its grandiose intentions and mediocre performance, it would
> be wise to question this new "role of government."
>
> Governments have done the most harm to societies and economies throughout
> history-no private entity can claim such extravagant carnage.

Feb 21 02:59 PM

[CJJ:]

Isn't it so easy to just blame the government. Yes they usually don't make things better but they keep things together. Why people think without action things would magically become better. The outcome would certainly be different but I really question that it would be better.


On Feb 21 02:12 PM dw57 wrote:

> not true. they just did. again. they caused what we call the great
> depression. and they have done it again

Feb 21 07:11 PM

[CJJ:]

Look to Somalia and I think we can agree that model sucks.


On Feb 21 02:59 PM EEB wrote:

> I completely reject the notion that viable and flourishing societies
> exist without government. Could you please provide some examples?
> Usually, I think of anarchy as quite chaotic, and the life therein
> tends to be not very pleasant. I think that there is strong historical
> evidence for this view starting with Thucydides.
>
> Our choice is not between horrible government and no government.
> That is a false dilemma. However, this does not mean that there aren't
> good and bad governments. I suggest that we search for ideas about
> what good government would look like, instead of repeating the naive
> view that the elimination of all government would lead to a flourishing
> society.

Feb 21 07:12 PM

[user225084-...:]

Keynes was a clever man, but I really wish he had come up with a more serious name than "animal spirits" to describe the psychological/behavior... component of human economic activity.

I would have expected Robert Shiller NOT to pick such a title of his new book, but perhaps the publisher thought "animal spirits" would play well with the more new-age "spiritual" type of consumers. It is a business to sell books, after all.

Feb 21 08:00 PM

[john s. gordon:]

sundrench - finland is racially homogeneous, and full of hardworking people, and it is relatively easy to develop a national consensus on what needs to be done.

u.s.a by contrast has many diverse attitudes about any number of things.
read 'nine nations of north america' by joel garreau.

remember finland was the only country that ever paid off its 1917-18 war debt to the u.s.a, they did it by imposing a reduction in living standards on all citizens, and there was general agreement that it was the proper thing to do.
> jack

Feb 21 08:18 PM

[sundrenched:]

Fair enough (about Finland), but it was just meant as an illustration. Singapore could actually be a ticking demographic bomb -- it is probably more diverse and in a demographically precarious situation than the US. It's a chinese-dominated city state in a muslim region where the native muslim minority is at the bottom of the socioeconomic ladder, mixed with an indian minority and hundreds of thousands of expats (who are on average much better off than the locals). My main point is well expressed by the other poster, that it's being presented as a false choice between bad government or no government, and that we need to think more about how to run government well (start by kicking out the lobbyists and taking all private money out of politics -- unfortunately most right-wingers don't want to go there because of the absolute belief in free speech, even if the free speech is nothing but a tool for corruption).

> Our choice is not between horrible government and no government.
> That is a false dilemma. However, this does not mean that there aren't
> good and bad governments. I suggest that we search for ideas about
> what good government would look like, instead of repeating the naive
> view that the elimination of all government would lead to a flourishing
> society.


On Feb 21 08:18 PM john s. gordon wrote:

> sundrench - finland is racially homogeneous, and full of hardworking
> people, and it is relatively easy to develop a national consensus
> on what needs to be done.
>
> u.s.a by contrast has many diverse attitudes about any number of
> things.
> read 'nine nations of north america' by joel garreau.
>
> remember finland was the only country that ever paid off its 1917-18
> war debt to the u.s.a, they did it by imposing a reduction in living
> standards on all citizens, and there was general agreement that it
> was the proper thing to do.

Feb 21 09:36 PM

[hoover:]

You have experiences in countries that most in the U.S.have not had. U.S. government today is heavily influenced by lobbyists. Their purpose for lobbying is to give the powerful more influence relative to the voting public. 100% lobbyist control would be a group dictatorship. 0% lobbyist control would be completely democratic -- but not necessarily good because of an ignorant public.

Size of government, it seems to me, should be measured by the amount of lobbyist control plus the amount of legal control over people plus the amount of the economy the government controls. Size should NOT be measured only the amount of the economy the government controls. I believe that a government that spends a lot on its people, is run efficiently, has minimal but not zero lobbyist control, encourages education and an strong incentive system to achieve rewads, and allows maximum freedom for people consistent with their security, may be ideal. Basically it is what you are saying: quality government can work well even if it is large. It also seems to me that our current system of government will implode over the next decade or so because of corrupt politicians, political infighting over selfishness and greed, lobbyist control to grab as much as possible by the super greedy, and a relatively dumb voting public that can't see it.


On Feb 21 04:49 AM sundrenched wrote:

> There's too much easy talk against "big" government and not enough
> about the quality of government.
>
> In the early 90s I lived in Finland, and in spite of astronomical
> tax rates (something like 70% of GDP if i remember correctly), people
> were OK with it, because they felt they were getting value for money.
> No one had to worry about schooling for their kids, healthcare, excellent
> quality daycare was provided for your kids, retirement, etc. etc.
> There were very few barriers between social classes -- what level
> you rise to depends mainly on your smarts and motivation. (In America,
> unfortunately there are real class barriers already -- yes, if you're
> extremely talented you can cross them, but not if you're just average
> smart -- to give you an example: most kids in Ivy League universities
> come from well-off backgrounds these days).
>
> Following some more travels, now I'm living in Singapore whch has
> a technocrat one-party system (most people here are OK with it as
> long as the ruling party delivers). Again, rather big government,
> but to make it to the top of the party you better be scary smart.
> Unfortunately, in the US, being articulate and likable are the top
> criteria, but that's for you to solve. Maybe time to talk about that
> for a minute instead of always railing against "big" government.
> Not to forget the sewer of corruption that lobbyists bring. But I
> forget, those guys are OK because that's "free speech"!

Feb 21 10:34 PM

[change is t...:]

behave irrationally;

THEN

groups should make all decisions;

ELSE

think for yourself.

Feb 22 03:33 PM