Book Review Animal Spirits Akerlof and Shiller

Human Behaviour Launches a Comeback in Macroeconomic Theory

Oct 7, 2009

Humpty Dumpty sat on a wall and then fell off it. Panic and lots of finger pointing ensued. In this post-Humpty era, Akerlof and Shiller return to Keynes for the answers.

Nobel prize-winning economist, George Akerlof and Yale Professor of Economics, Robert Shiller in their book, Animal Spirits – How Human Psychology Drives the Economy and Why It Matters for Global Capitalism, set out to bring John Maynard Keynes’ buried theory of animal spirits back to the foreground of macroeconomic theory.

Behavioural Economics

According to both authors, human psychology or in Keynes' terminology, animal spirits, can explain not just this recession, but all those preceding it, in a way the current bent toward an unaccountable faith in the rationality of economic decision making cannot.

“Just as Adam Smith’s invisible hand is the keynote of classical economics, Keynes’ animal spirits are the keynote to a different view of the economy – a view that explains the underlying instabilities of capitalism,” say Akerlof and Shiller.

Statements such as this are the beating heart of the relatively new field of behavioural economics and it is interesting, but not surprising, to note that Keynes himself was a little enamoured with what would now be considered the ‘dark side’, particularly since he penned The General Theory of Employment, Interest and Money in the wake of The Great Depression.

Animal Spirits

In their revival of Keynesian theory, George Akerlof and Robert Shiller, point to five animal spirits, which they consider influential forces in the economy and players in the mania and panic cycles evident in both property and stock markets.

Akerlof and Shiller consider the effects of both over-confidence and under-confidence, attitudes to fairness and its opposites, corruption and bad faith, as well as people’s tendencies toward money illusion, where inflation is often discounted and the viral transmission of stories of extreme optimism or pessimism which can pervade societies at certain times.

A Call for Government Intervention

These authors argue that since markets are beset by decision making which is at times non-economic in nature and irrational, Adam Smith’s invisible hand does not pack the wallop it should. They suggest a firmer hand, a parental hand, is needed in the form of government invention.

“...left to their own devices,capitalist economies will pursue excess, as current times bear witness. There will be manias. The manias will be followed by panics. There will be joblessness. People will consume too much and save too little,” say Akerlof and Shiller.

The Verdict

If this is all sounding a little paternalistic, with governments exerting parental-like control over their unwitting charges, forgiveness could be extended due to the extreme and extenuating economic climate and the mania and panic amongst economists whose job it is to explain how things work and when they don’t work, why not? It seems economists themselves are prone to excess also and the opposing free market theorists are no different.

However, George Akerlof and Robert Shiller in their book, Animal Spirits, How Human Psychology Drives the Economy and Why It Matters for Global Capitalism, do revive a different framework by which to view recent events where action, rather than inaction, is warranted and the outrageous permissiveness of the past is placed firmly into perspective.

The Details

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