Book review: Animal Spirits by Akerlof and Shiller

All of this was pretty much commonsense which even as a non-financial person, I knew several years ago even before the housing bubble burst. The criticisms of Friedman’s use of rational agents and varying inflation expectations are poor , especially when Keynesian economics has much more rigorous criticisms. Akerlof and Shiller are not suggesting an abandonment of mathematics in Economics, but advocate the inclusion of psychological probabilities. animal spirits What they suggest is that humans do not have access to perfect information, nor do they act in an entirely rational matter. Overall, this is the best and most comprehensive book I’ve read so far on the sea change in economics that has been taking place during and in the wake of the two great economic boom / busts of the past dozen years. Shiller’s 2008 book, The Sub-Prime Solution, is also a great read, though more narrowly focused.

From blind faith in ever-rising housing prices to plummeting confidence in capital markets, «animal spirits» are driving financial events worldwide. The first quarter divides animal spirits into five categories. The phrase “animal spirits” comes from John Maynard Keynes, the great British economist, who saw the role of emotion and irrationality as looming large in economic behavior. As Akerlof and Shiller see it, Keynes had it right, but the neo-Keynesians who followed him watered his theories down to conform more closely with the “invisible hand” classical economics of Adam Smith. This is the version of economic thinking that Akerlof and Shiller attack. Two Nobel Prize-winning economists, George Akerlof and Robert Schiller, use their version of Keynes’s theory of «animal spirits» to explain past financial crises and how economies grow.

• But in “Animal Spirits,” they have deviated — and they have done so just as mainstream theory self-destructs.
• Having gotten to know these characters, this was a very difficult scene to get through; in fact, we’ve given up on the series on account of it.
• If you took a macroeconomics class in college, you will know all the theory in great detail.
• But the paradigm shift didn’t happen then, because Hicks distorted Keynes’s vision into something quasi-neoclassical, making what could have been a fundamental advance into a incremental improvement.
• The chapter that focuses on how to resolve the current crisis is disappointingly standard fare, similar to what can be found in most economics textbooks.

While writers of macroeconomic theory have until now relegated the idea of ‘animal spirits’ to the appendixes of textbooks, the authors argue that theorists must give greater prominence to the role it plays within economics. In the book, the authors borrow the term “animal spirits” from John M. Keynes’s “General Theory of Employment, Interest and Money” to criticize the mainstream standard model of human rationality. Keynes had used the term to exactly describe the imponderable human factor in massive economic behavior and outcomes — in all its irrationality. George Akerlof and Robert Shiller’s book, Animal Spirits, offers an accessible look at how traditional economics can be expanded by incorporating some basic concepts from psychology.

Book Review: ‘Animal Spirits’ by George Akerlof and Robert Shiller

Economists create impressively complex formulas attempting to accurately describe the state of the economy and predict future trends. However, there are just too many unquantifiable variables – feelings, emotions, intuition, and confidence– to accurately incorporate all available information into a simple neat equation. Incorporating psychology into economics may not sound like much of a breakthrough. But Akerlof and Shiller have stepped outside of current economic thought to gently nudge animal spirits back to the discipline. Alas animal spirits are hard to quantify, thus the fierce opposition by economists. But the book is definitely a fundamental work in the development of economics as a science as opposed to economics as a doctrine.

The book’s agenda is initially described as being fairly ambitious, setting about to do no less than change the way we interpret and understand economic events. The authors assert that the Keynesian Revolution was emasculated as Keynesians progressively relegated the importance of animal spirits to accommodate the views of economists who preferred the simpler classical or neo-classical system. A different problem arises in moving from explanation to prescription. Akerlof and Shiller argue convincingly that animal spirits give a richer and truer account of economic fluctuations. How to manipulate them for policy purposes, and when it might be right to try, are separate questions. The authors are doubtless sympathetic to the case for «libertarian paternalism» in Nudge, by Richard Thaler and Cass Sunstein – another valuable book that explores the possibilities of «behavioural economics».

The second half is much better, though I think it overstates its case. The book also suffers from being written in the teeth of the financial crisis, so its triumphalist claims to understand its exact causes are a little hubristic. I’d argue on the psychology side that it is missing a few key explanatory factors, loss aversion, optimism bias, acclimatisation. On the economics side, it lacks awareness of Richard Koo’s concept of the balance sheet recession and a more nuanced understanding of complexity economics, non-linearity and the disequilibrium they imply. Still the book serves as a valuable brick in the wall of modern economics, I’m just not sure it’s load bearing. The book comes in two parts – part one is about the various ‘animal spirits’ that direct the ways in which we think about and act within the economy.

Higher progressive income tax on dollar compensation coupled with lower taxes on options compensation might accomplish this. The authors do not consider and rebut the natural counter-argument on who regulates the regulators – as regulators are also human beings subject to errors and biases – which may ultimately cause other economic imbalances. The book though is a powerful shot taken by two of the most prominent economists nowadays in support of more regulation of the economy in the old-never-ending dispute between free-market supporters and interventionists. I’m also gobsmacked at how Alerlof & Shiller have taken the main tenants of Hyman Minsky’s Financial Instability hypothesis and not referenced him?! Uncertainty and animal spirits are what drive cycles in Minsky’s model and yet they argue that they are on new territory. Furthermore, they talk about fairness in wage demands and put forward their perception that this is an under appreciated topic…if only this wasn’t a main pillar of Post Keynesian theory of wage demands/inflation….

Chapter 8 tackles the reasons for unemployment, which the authors say is partly due to animal spirits such as concerns for fairness and the money illusion. Here the authors discuss eight important questions about the economy, which they assert can only be satisfactorily answered by a theory that takes animal spirits into account. What are these animal spirits that drive the American economy? Far from dispassionately weighing and analyzing all the options, people act on the confidence, or overconfidence, that a home they are about to buy will be worth more a year later. Confidence drove up stock ­prices in the 1920s and again in this decade, far more than corporate balance sheets and pure reason would justify, and now lack of confidence, spreading like a contagious disease, is exacerbating the sell-off. To be brought to them from either a fancy hotel or a run-down supermarket.

ANIMAL SPIRIT

Economic Facts and Fallacies exposes some of the most popular fallacies about economic issues-and does so in a lively manner and without requiring any prior knowledge of economics by the reader. Akerlof and Shiller spent five years writing “Animal Spirits” and honing that conviction. They are concerned that once we enter a revival, pressure will inevitably build — just as it did in the late 1970s, more than a generation after the Great Depression — to give the markets free rein again. Akerlof and Shiller intend their book as an obstacle to that ever happening. Pre-publication book reviews and features keeping readers and industry influencers in the know since 1933.

In “There Might Be Blood,” a New Yorker takes a two-month break from her troubled marriage to live in Rome. When hostile sea gulls beset her terrace, she hires a sea gull remover and finds herself obsessed, “like being in love,” with his hawk. Avian aggression exposes marital truths the woman has been avoiding. In the final story, “The Call Back,” an American film director in Rome meets the woman who inadvertently caused his older sister’s death 25 years earlier.

Editorial Reviews

Animal Spirits is an well-written treatise accessible to both economists and non-economists alike. It summarises well the areas where behavioural economic research indicates real deficiencies in current macroeconomic models; what it does not do is propose obvious alternative models that are not themselves subject to obvious problems. The preface goes on to describe how Keynes’ ideas suggest the economy will function best with a moderately high level of government intervention, which they compare to a happy home where children thrive with parents that are neither too authoritarian nor too permissive . A little awkwardly, the authors have tacked an excellent postscript, about what needs to be done, on a chapter about monetary policy. The connections between their thinking on the limits to conventional economics and the issues thrown up by the breakdown are plain, even if they were unable to make every link explicit. Even more than Akerlof and Shiller could have hoped, therefore, it is a fine book at exactly the right time.

A warning on how misleading the neoliberal understanding is, this so-called animal spirit, such as fairness, corruption, race, etc governs much of market behavior, which can’t be reduced to economic calculations. The 5-star is for how Prof. Shiller managed to make a complicated topic sound comprehensible and tie it back to common-sense language. It definitely didn’t feel this way when I studied the Philips curve at uni, he made it sound so simple, such is the clarity of the writing and the econ wisdom.

The authors’ criticisms of the standard model are well taken and not that controversial. The orthodoxy assumes rational optimising behaviour, and is reluctant to contemplate more than minor deviations from that principle; as a result, it often goes astray. Ad hoc modifications, such as those the authors suggest, may get better results. This is a good moment to propose a re-examination of orthodox economics. The current breakdown, possibly the worst since the Great Depression, was a shock to all but a handful of economists.

Community Reviews

Death’s lasting power echoes back through the stories, but Marciano’s closing lines offer hard-won hope. That being said, the text stands as a skilful takedown of macroeconomic hubris and overreach, and on that basis it merits a read for any readers interested in improving macroeconomics — if for no other reason than to know what its blind spots are. I have read a lot of these types of books recently and this is the most accessible. The universe, by contrast, does not appear to be made of stories.

I am sick of the economic theory that assumes we are robots who calculate their every next move, only caring to maximise utility. Behavioural economics has been around for so long that it should be widely accepted in textbooks and undergraduate courses. As Lears memorably demonstrates, the belief in the significance of pulsing flows of energy that move through minds and objects has played a profound, if not often well-acknowledged, role in American philosophy and lived experience. The authors effectively define a number of ‘animal spirits’ that are at work in the economy, and then they go on to show how they can be applied to major problems which face economists.

The term “animal spirits,” originally coined John Maynard Keynes in the 1930’s, describes how impulses and emotions naturally lead to economic boom and bust cycles. Traditional economists seem to have ignored even the most primitive of these spirits. Animal Spirits is an important critique of how modern «scientific» and «quantitative» macroeconomics has failed to predict or adequately explain important phenomena in economic history, the last of which being the Great Financial crisis of this millennium.

There is a discussion about feedback loops between animal spirits and real returns available, which help explain the intensity of both the up and down swing of the cycle. There was nothing rational, well ­informed or unemotional about the behavior that has all but collapsed the economy. That leaves most of America’s economists without a believable framework for explaining how we got into this mess. Akerlof and Shiller are the first to try to rework economic theory for our times.

The book offers persuasive, well-researched, prose that challenges the conventional wisdom that underlines much of existing economic theory. In attempting to answer some large fundamental economic questions by calling attention to psychological influences, the book offers a first glimpse of what economic solutions might look like in the future. Economists, in pursuit of mathematical precision, seem to have forgotten that not everything can be easily counted.

Animal Spirits is a weekly podcast where I get together with my friend and colleague Michael Batnick to discuss what we’ve been reading, researching, writing, watching, listening to, and thinking about. We talk about all things financial markets, https://forexarena.net/ personal finance, our favorite books, movies, and TV shows, parenting, the asset management business and more. Our goal is to make finance more accessible, speak in plain English, and share our own personal experiences in the markets.

The book was written in response to the financial crisis and the authors are economics rockstars. Robert Shiller and George Akerlof are Nobel laureates and Keynsians who believe that government has an active role to play in macroeconomic management. The investment community will recognize Shiller as the prescient economist who predicted the collapse of the tech bubble in 2001 and the housing bust in 2008 and who developed the Case Shiller Home Price index. Akerlof introduced important theories showing the impact of asymmetric information, moral hazard and adverse selection.

Akerlof and Shiller are great economic thinkers who systematically approach economics from the ground up, and focus on how our «animal spirits» affect the economy. Much work has been done in behavioral economics in recent years and this study gives excellent synopses. Akerlof and Schiller take to task ‘mainstream’ classical economics in certain areas, but in a very fair way, acknowledging where ‘rational’ theories seem to hold, while pointing out those ever-important situations where they fail.