{"id":2049,"date":"2012-03-30T20:45:41","date_gmt":"2012-03-30T19:45:41","guid":{"rendered":"http:\/\/www.mmcgrath.co.uk\/?p=2049"},"modified":"2020-04-22T02:46:35","modified_gmt":"2020-04-22T01:46:35","slug":"fridays-words-of-wisdom-animal-spirits-by-akerlof-and-shiller","status":"publish","type":"post","link":"http:\/\/www.mmcgrath.co.uk\/?p=2049","title":{"rendered":"FRIDAY’S WORDS OF WISDOM: ANIMAL SPIRITS BY AKERLOF AND SHILLER"},"content":{"rendered":"

\"\"<\/a>Animal Spirits: How Human Psychology Drives the Economy and Why it Matters for Global Capitalism<\/em> by George A Akerlof and Robert J Shiller (Princeton University Press, 2010) starts with the argument that traditional economic models based on rational actors and perfect markets cannot explain the economic crisis we currently face and cannot point us in the direction of policies that will solve that problem. At the most basic level, they argue that economic textbooks:<\/p>\n

\u201cdo not give much enlightenment about the ultimate drivers of the economy. They do not do so because the understanding of drivers must lie somewhat outside the traditional boundaries of economic research, in the realm of psychology… which is an intellectual tradition alien to most economists. Macroeconomists have found it difficult to formalise the concept of animal spirits on their own terms, so they have largely neglected it.\u201d (iii)<\/p><\/blockquote>\n

They seek to revitalise Keynes\u2019 idea that the economy is driven by more than the rational economic maximisation found in classical economic theory and Adam Smith\u2019s “invisible hand” delivering optimal outcomes. They argue that Keynes’ animal spirits<\/em> (human psychological factors) have a profound influence the state of the economy. In the view of Keynes:<\/p>\n

\u201cthe economy is not just governed by rational actors, who \u2018as if by an invisible hand\u2019 will engage in any transaction that is to their mutual economic benefit, as the classicists believed. Keynes appreciated that most economic activity is governed by animal spirits<\/em>. People have noneconomic motives. And they are not always rational in pursuit of their economic interests. In Keynes\u2019 view these animal spirits<\/em> are the main cause for why the economy fluctuates as it does. They are also the main cause of involuntary unemployment. To understand the economy then is to comprehend how it is driven by the animal spirits. Just as Adam Smith\u2019s invisible hand is the keynote of classical economics, Keynes\u2019 animal spirits are the keynote to a different view of the economy \u2013 a view that explains the underlying instabilities of capitalism.\u201d (xxiii)<\/p><\/blockquote>\n

After the publication of Keynes\u2019 The General Theory<\/em> those who took up his work \u2013 most notably Hicks \u2013 set about removing the animal spirits<\/em> from their interpretation of the work and reducing the differences between Keynes\u2019 vision and the standard classical economic models of the day in which people only acted rationally. This watering down of Keynes\u2019 work left it vulnerable to Friedman and the \u201cNew Classical Economics\u201d that argued that the remaining differences between Keynesianism and the rational actor model were too insignificant to make any difference. The distinctive elements of Keynesian economics were laid aside and the idea of the invisible hand in free markets was re-established. But the crises in the global economy cannot be explained by the reductive models of the classical and neo-classical economic theorists.<\/p>\n

“To understand how economies work and how we can manage them and prosper, we must pay attention to the thoughts patterns that animate people\u2019s ideas and feelings, their animal spirits<\/em>. We will never really understand important economic events unless we confront the fact that their causes are largely mental in nature… economists and business writers apparently do not seem to appreciate this… They assume that variations in individual feelings, impressions, and passion do not matter in the aggregate and that economic events are driven by inscrutable technical factors or erratic government action. In fact… the origins of these events are quite familiar and are found in our everyday thinking. (1)<\/p><\/blockquote>\n

Current economic thinking seeks to build models that minimise, as much as possible, departures from pure economic motivations \u2013 they seek to preserve the elegance of the pure, mathematical models around which much of the economics profession is built.<\/p>\n

\u201cThere is a good reason for doing so… The economics of Adam Smith is well understood. Explanations in terms of small deviations from Smith\u2019s ideal system are thus clear, because they are posed with in a framework that is already well understood. But that does not <\/em>mean that these small deviations from Smith\u2019s system describe how the economy really works… In our view economic theory should be derived not from minimal deviations from the system of Adam Smith but rather from the deviations that actually do occur and that can be observed. Insofar as animal spirits exist in the everyday economy, a description of how the economy really works must consider those animal spirits.\u201d (5)<\/p><\/blockquote>\n

The book describes:<\/p>\n

\u201cfive different aspects of animal spirits and how they affect economic decisions \u2013 confidence, fairness, corruption and antisocial behaviour, money illusion and stories<\/em>:<\/p>\n