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  • Book Review: Animal Spirits by Shiller and Akerlof 1 comment
    Jun 26, 2009 5:28 AM

     "Some books are to be tasted; others swallowed; and some to be chewed and digested." 

    -Francis Bacon

    Animal Spirits clearly falls under the “chewed and digested” category. Economics is in a state of crisis and there's been much debate about the myth of efficient markets and rational human beings. This book presents a framework to explain the nature of markets, and the importance of human psychology in it. Don’t be fooled by the thin appearance! Instead of a quick read, you’ll find pages which challenge conventional wisdom every step of the way.

    The authors are famous economists. Mr. Akerlof won a Nobel Prize in 2001, while Robert Shiller first gained prominent recognition with his book “Irrational Exuberance”, which was published just before the stock market peak in 2000. The second edition, out in 2005, warned about the bursting of the housing bubble.

    So what are animal spirits? Animal spirits are essentially thought patterns that animate people’s ideas and feelings. The book describes five different aspects of animal spirits and how they affect economic decisions – confidence, fairness, corruption, money illusion and stories. Confidence is procyclical, and is similar to the Keynes multiplier. When confidence is up, asset prices start rising. Fairness basically influences wages. The authors consider whether concerns about fairness and social expectations trump the consequences of strictly economic motivations. Money illusion refers to the fact that participants can’t seem to see through inflation. “Stories” is a term to describe ideas that become widely accepted in the society. For instance, the internet mania in the late 90s and the “house prices never go down” mantra were widely accepted “stories”.

    The authors use their animal spirits theory to answer the following questions:
    "Why do economies fall into depression? Why do central bankers have power over the economy? Why are there people who can’t find a job? Why is there a tradeoff between inflation and unemployment in the long run? Why is saving for the future so arbitrary? Why are financial prices and corporate investments so volatile? Why do real estate markets go through cycles? Why does poverty persist for generations amongst disadvantaged minorities? “

    For instance, to explain why economies fall into depression, they show how the previous depressions in the US occurred due to fundamental changes in confidence in the economy, in the willingness to press pursuit of profit to antisocial limits, in money illusion, and in changes in the perception of economic fairness. Their discussion on the power of the central bankers is extremely relevant in today’s environment.

    The book makes a compelling case that it might be time to redesign financial regulations to take account of the animal spirits that often drive markets, to make markets work more effectively, and to minimize bailout costs. The question of animal spirits is important, as “the future of any country is in the hands of the business people who decide on investments, and it is in large measure dependent on their psychology."

    Some of the unresolved questions which the authors ask in conclusion are actually being addressed by the financial reforms currently being debated. While Animal Spirits may not provide a miracle-cure for our current predicament, it’s an important first-step in understanding the role of human psychology in driving our economy. On a scale of 1 to 10, where 10 would be a gastronomical delight, I’d give this one an 8. Go check it out!
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  • WillyP
    , contributor
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    Are you serious? This book is most definitely not about economics. If anything, its classification is closer to consumer/mob psychology. Economics is distinct from psychology - i.e., it is a different branch of knowledge. Economics analyzes action, not the drive behind the action (that would be psychology). Importantly, any good economist will treat money and prices seriously. Shiller and Akerlof fail to adequately explain the role that money plays in establishing relative prices.

     

    In their assessment of why economies fall into depression, Shiller and Akerlof target confidence, which drives up asset prices. A good question to ask is: where does the money to pay for these astronomical prices come from in the first place? The answer is inflation; whether this inflation comes from fractional reserve banking or the Federal Reserve is largely irrelevant.

     

    Only inflation - or legal counterfeiting - can distort markets on such a grand scale. With a system of a hard money, such extreme aberrations are highly unlikely. Furthermore, their "cures" amount to further price distortion and will prolong this recession and increase unemployment.

     

    A necessary corrective to this thinking can be found in the works of Hayek or Mises or Reisman. I can't say I was impressed in the least, but reading this book did convince me that our academic and institutional economics are in disarray.
    30 Jun 2009, 04:05 PM Reply Like
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