Guest Post: Discussion of "Animal Spirits" by George Akerlof and Robert Shiller

Submitted by DoctoRx, who comments on the economic and financial scenes at EconBlog Review:

In thinking about Animal Spirits, I am reminded of Spencer Tracy’s comment about Katharine Hepburn in Pat and Mike: “Not much meat on her, but what’s there is cherce.” There’s not much meat on the bones of Animal Spirits, and what’s there is not so choice.

Drs. Akerlof and Shiller argue that modern economics has lost its way by ignoring the psychological aspects of economic behavior. They refer to Keynes’ mention in his General Theory (1936) of the need for “animal spirits” to arise, and therefore engender risk taking to lead the economy out of Depression. The authors adapt the “animal spirits” term to their own broader use, explaining the subtitle: How Psychology Drives the Economy, and Why It Matters for Global Capitalism.

Reviewing and decrying the history of economics morphing into a “science” related to mathematics, they make the sweeping statement:

In our view economic theory should be derived not from the minimal deviations from the system of Adam Smith but rather from the deviations that actually 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 these animal spirits. This is the aim of the book.

They continue

In producing such a description, we think that we can explain how the economy works. This is a subject of permanent interest. But, writing as we are in the winter of 2008-9, this book also describes how we got into the current mess- and what we need to do to get out of it.

They really are saying that a proper theory of how economies work should be derived in toto from exceptions to Adam Smith’s system. Unfortunately, they do not demonstrate how they intend to prove this big point to their academic confreres.

The book lays out five categories of animal spirits, with the authors’ explanatory quotes where appropriate:

1. “The cornerstone of our theory is confidence and the feedback mechanisms between it and the economy that amplify disturbances;”

2. “The setting of wages and prices depends largely on concerns about fairness;”

3. “Corruption and antisocial behavior” and the perception of the existence and pervasiveness of such.

4. “Money illusion is another cornerstone of our theory. The public is confused by inflation and deflation and does not reason through its effects;”

5. “Stories”- perhaps a catchall for themes, culture, and big picture stuff as people perceive it.

DoctoRx here. Surely modern economists are aware of money illusion, as they are that confidence or lack of such affects all sorts of economic variables. Can an entire new theory of economics really be derived from these variables? What predictive rather than post hoc value, would they have? The Governor of a State who wants to know if raising a sales tax from 5% to 6% would generate much additional revenue is likely well served by existing formulae derived from observations plus evolving theory. How would he/she take into effect any perception by the State’s residents that he/she for example is/is not corrupt or that the people’s mood is sour or ebullient?

In my very humble opinion, these five categories are interesting but don’t add nearly as much information to economics as the authors say they do.

After discussing the above five categories, the authors list eight major economic decisions and boldly assert:

We see that animal spirits provide an easy answer to each of these questions. (Emph. added)

Here is where they began to truly lose me. Any time anyone, even a Nobel Prize winner and a superstar, says there is an easy answer to complex problems, and tells the public of this easy answer before convincing their academic colleagues, one should be on guard. Sadly, this statement reminds me of the latest over-the-counter miracle cure for some ailment or for multiple ailments. Akerlof and Shiller go on to say:

In answering these questions, in telling how the economy really works, we accomplish what existing economic theory has not.

The above statement is so sweeping that it was immensely disappointing to fail to find persuasive arguments to support it. Argument by anecdote and implication is inadequate to the heavy task they set themselves.

The eight questions include why there is not full employment, why do central bankers have power over the economy, why do depressions occur, why is there special poverty among minorities, among others.

Moving on to current events, the authors say that “the crisis was not foreseen . . . because there have been no principles in conventional economic theories regarding animal spirits”.

I have to disagree both that the crisis was not foreseen and that known principles could not have predicted/explained it.
On the first point, Nassim Taleb predicted there would be a major crisis when he saw the balance sheets of Fannie Mae and Freddie Mac several years ago. He just did not know when all the leverage would blow them up. He makes clear that in his view, this crisis was NOT a black swan event. Similarly, Nouriel Roubini grasped from his experience with emerging market currency, financial and economic crises that this mess was brewing. Either Dr. Roubini was tremendously lucky, or he was clearly on to something when in the winter of 2008 he laid out a set of predictions for the crisis that more or less all came true. What happened with the freeze-up of credit did not stem from irrational behavior and does not need a new theory of economics based on behavior psychology to explain it pre-or post-event. After the events involving Fannie and Freddie, then especially Lehman and AIG, counterparty risk was real and major. Reluctance to lend was rational, no matter how much Drs. Shiller and Akerlof argue otherwise. Reluctance to lend remains rational due to declining credit quality; the authors state that this reluctance needs behavioral psychology to explain it.

What new theories are required to understand that excessive and poor lending practices can blow up?

The authors say that the current mess could not have happened for rational, predictable reasons. Many disagree. It can be asserted that the individuals in the financial community acted rationally, maximizing their individual wealth. In January of 2008, a stock broker told me that bankers always take excessive chances, knowing that the Fed or Government (nowadays one and the same for all practical purposes) will bail them out of their mistakes. Homebuyers thought they were rational. They “knew” that house prices always trend up. Leveraged borrowers were rational if they were playing with Other People’s Money; heads I win and you do OK, tails you lose and I neither win nor lose (or win less than if heads came up).

The book asserts:

We provide a theory that explains fully and naturally how the U. S. economy, and indeed the world economy, has fallen into the current crisis. And- of perhaps ever greater interest- such a theory allows us to understand what needs to be done to extricate ourselves from the crisis.

Again I beg to differ.

From a policy standpoint, the actions taken by Presidents Bush and Obama, Fed Chairman Bernanke, Congress, etc., are conventional policies that required no new theories of animal spirits to be thought of or to be implemented. Akerlof and Shiller simply support what’s been done. They propose no new programs or domestic psych-op campaigns to bring behavioral economics insights to bear to turn the economic tide. These facts severely undercut their assertions quoted above.

The authors also have a political agenda that confuses the reader who wants to focus on their core theories. Dr. Akerlof is married to Janet Yellen, a Democratic stalwart and currently head of the San Francisco Federal Reserve Bank. One can hear the contempt drip when they mention Reaganism and Thatcherism only with regard to deregulation; they ignore the fact that Jimmy Carter began the deregulatory movement. The authors both overstate the importance of monetarism in U. S. policy since 1981 and appear to blame its use on Republicans. It was actually a Democrat, Paul Volcker, who implemented monetarism when he ran the Fed; Ronald Reagan was a Keynesian. Keynesians have served as President and have run Congress for years, Republican and Democrat alike. You would not know this from the book.

Again bringing politics into the book, the authors go farther than the facts allow in arguing for full employment. They say:

This had been the vision in previous generations of those who established central banks: the role of central banks is to insure the credit conditions that enable full employment.

This would be news to those who made the Bank of England the central bank, rather than just any old bank. In what were the monarchs of 17th and 18th Century England really interested? European and world domination, yes; marvelous living conditions for the populace, hardly. It would also be news to the New York Fed, whose Web site states that the Federal Reserve Act “provided for the establishment of Federal Reserve Banks, to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes.”

Moreover, the U. S. Fed of course has a dual mandate of balancing full employment with inflation considerations. The European Central Bank has a single mandate, dealing with inflation alone rather than full employment; the feeling in Europe was that unemployment considerations should be dealt with by elected governments, not central bankers.

Finally, the authors state flatly that an important part of their theory if implemented would be that the government would be analogous to a parent who should “set the limits so that the child does not overindulge her animal spirits”. This becomes circular: who regulates the regulator; who protects the Fed Chairman from irrational exuberance? What happens when the Government gets it wrong, but the people get it right? The parent-child analogy is more than a bit condescending.

SUMMARY: Animal Spirits repeatedly fails to prove or even strongly support its major, overly broad theses, and veers off at times into unnecessary and poorly-supported partisan political rhetoric. The book would read better if the authors had checked their political agenda at the door. I was left with the unpleasant feeling that this book was written more for mercenary and political reasons than academic ones.

Print Friendly, PDF & Email


  1. Mrs. Watanabe

    I've read the book; it's extremely disappointing, but then, all those types of books are.

  2. DownSouth

    @DoctoRX said: "Ronald Reagan was a Keynesian."

    That statement left me kind of scratching my head, and then I happened to remember this:

    The Democratic presidential cycle that began in 1933 soon introduced the willing use of deficitry and debtcraft, reflecting the spend-to-stimulate theories of John Maynard Keynes, whose view had become so widespread by 1970 that Richard Nixon acknowledged that "we're all Keynesians now." In fact, the inflation of the 1970s was about to end Keynes's ideological reign. Yet many Republicans besides Nixon remained under partial influence. By the Reagan years, besides encompassing supply side tax-cut theology and monetarist faith in currency expansion and shrinkage, the ranks of conservative Republicanism included tax-cut Keynesians (deficits are fine if you're giving money back to the folks who count), military Keynesians (the Pentagon houses government's most deserving function), pork-barrel Keynesians (more roads and projects, and then some more), and even bailout Keynesians (large or well-connected financial institutions have to be rescued). By the decade's end, as the philosophers of debt usefulness finished lining bookshelves with their paeans to junk bonds, leveraged buyouts, "deserving deficits," tax cuts no matter what, and the belief that current-account deficits signify only foreign hunger to invest in America, the debt fox was loose in the fiscal henhouse.

    Kevin Phillips, American Theocracy

  3. joebek

    What about the teaching of Austrian economics, viz. the boom causes the bust. This is almost universally accepted now in the observation that Greenspan caused the boom/bust by keeping interest rates too low for too long. The systemic significance of the observation is yet to be developed. Probably too many academic careers are at stake. In this sense the main beneficiaries of the bailouts and stimuli are economists.

  4. Blissex

    «On the first point, Nassim Taleb predicted there would be a major crisis [ … ] Similarly, Nouriel Roubini grasped from his experience with emerging market currency, financial and economic crises that this mess was brewing. [ … ]»

    Many others realized that excessive credit and fictitious capital gains would cause trouble… One of the earliest published predictions was by Michael Hudson, in 2003 and even in 1998:

  5. Thomas

    Was Reagan really a Keynesian? The way I remember it, he believed that lowering taxes would lead to more revenues due to the Laffer Curve. If he believed in deficit spending, he certainly didn't say so in public. Or am I mistaken?

  6. Thomas

    Quote joebek: "This is almost universally accepted now in the observation that Greenspan caused the boom/bust by keeping interest rates too low for too long."

    But the low interest-rates didn't by themselves cause the bust. Irrational overborrowing caused it. Market participants weren't forced to do what they did just because interest-rates were low.

  7. joebek

    Thomas@8:22 "But the low interest-rates didn't by themselves cause the bust. Irrational overborrowing caused it. Market participants weren't forced to do what they did just because interest-rates were low." If something appears irrational in hindsight does not mean that it appeared irrational to market participants at the time. Classical economics teaches that if profits are being made in a particular line of business more people will seek to participate. Profits were being made in housing in 2003,4,5,6. That the man in the street or even the typical Wall Street investment banker should understand that this profitability was illusory is too much to expect.

  8. Benign Brodwicz

    Akerlof and Shiller ignored some research not coming out of the economics mainstream on "animal spirits" that ties measured economic confidence to the foundations of biology and physiological psychology, "Adaptation level and 'animal spirits'," JEconPsych (1996), (see also "Animal spirits in America, April 2009," for summary). I am proud to feature updates on this obscure research at

    Confidence levels as reflected in survey measures are largely driven by how good things are relative to what we've experienced in the recent past. Currently we're adapting somewhat to bad circumstances and the "animal spirits" are rising–with the danger of complacency toward our structural problems. It's all relative.

    Like that of animals, our behavior (consumption, investment, reproduction) responds to changing environmental conditions. The sensitivity to adaptation level seems to be a heuristic that nature uses virtually universally across cognitive and perceptual categories to judge things.

    Shiller and Akerlof highlight issues that are likely contributors to our confidence levels in a more static context.

    I am especially sympathetic to the notion that there are degrees of income and wealth inequality that are "optimal" in the sense of promoting teamwork and productivity, but this area is politically charged and faces a taboo of long standing in academic economics. Marginal productivity theory is still the approved fairy tale.

    Why should our executives be paid so much more relative to the average worker than executives in other developed countries? Or than they used to be? The new inequality wasn't always the case, and does not seem to have helped us in any way.

    For a somewhat impressionistic but impassioned argument that the root cause of our current "failure of effective demand" is the unequal income distribution (the pile-up of unsupportable debt was a follow-on enabled by the Fed), see .

    The basic challenge we face is that the American social contract is broken and needs to be renegotiated, top to bottom. Shiller and Akerlof don't quite get this far. For a prophetic work making this case that predicts a major crisis in about ten years, see The Fourth Turning, by Strauss and Howe (1997), two Beltway economists who made the leap all the way out of mainstream economics into long-wave econo-historical theory (and are best known for their generational archtype analysis).

    Shiller and Akerlof, in their roles as philosophers, accrue many good insights. However, the research cited above provides a workable model of what drives measured "animal spirits" over a typical business cycle, and may deserve further consideration.

    Benign Brodwicz

  9. rootless cosmopolitan

    "What about the teaching of Austrian economics, viz. the boom causes the bust. This is almost universally accepted now in the observation that Greenspan caused the boom/bust by keeping interest rates too low for too long. The systemic significance of the observation is yet to be developed."

    How could it be an "observation" that Greenspan caused the boom/bust? It is not an observation that Greenspan did. It is a claim and a widely accepted belief, instead. The claim has not been proven, though. The claim would have to be proven first using data within a theoretical framework.

    The claim basically says that the Fed would be able to control market interest rates of credit that has a volume of many trillions US-dollars, just by tuning a tiny parameter like the Fed funds target rate, which directly controls only the interest rate for which banks lend their excess reserves to each other. The amount of this lending is small compared to the total credit volume in the markets. Why would this tiny parameter control market interest rates? I challenge the wide belief that the Feds "low interest rates" were the cause for the credit bubble.

    For instance, it is claimed that the downward trend of the 30yr mortgage rate from year 2000 on was the effect of the lowered Fed’s target rate. However, if we look at the data,

    they show that the 30yr mortgage rate started to move lower about 1/2 year before the target rate was cut in Dec. 2000. The correlation between the long-term rates and the Fed’s target rate is weak. According to the data, if at all, the Fed’s target rate rather seems to follow the direction of the long-term interest rates with a lag of a few months or, if the target rate changes independently, the long-term rates are barely influenced. Recent developments, since the recent major economic crisis started to unfold, also contradict the common belief that there was a close link between the Fed’s target rate and market interest rates. As if market interest rates have cared about the slashing of the target rate to effectively Zero. Even short-term market interest rates have shown their own mind, when credit got crunched.

    The data shown above rather support an alternative explanation that says the Fed mainly reacts to the general trend in market interest rate, instead of controlling them. This raises the question what really caused the low interest rates in the markets.

    What about following hypothesis: Low market interest rates were caused by an over-accumulation of capital in the hands of the owning and investing class. The recent over-accumulation cycle started in the early 80ies with the Reagonomics, with tax-cuts and de-regulation that increased the profit margins for the owning and investing class too a large degree. Money always has to be invested as capital to get a return from it. A lot of the capital went into the credit markets, since there was too much capital to deliver sufficient profit margins from investments in productive sectors of economy. If you have an oversupply of capital in the credit markets it lowers the interest rates.


  10. joebek

    RC@10:50AM. The "savings glut", "oversupply of capital" thesis just seems strange. It's a little bit like explaining unemployment on agricultural productivity. It has a certain superficial plausibility but can it really be taken seriously? However, in one respect this thesis jibes perfectly with the Austrian theory of the business cycle. If existing savings can be levered up 20, 30, 40, 50 times through bank credit then we can see a perfect explanation of all the malinvestment.

  11. juan

    'Animal spirits', fine. But there may be less subjective ways to look at it…So,

    Lets go back to Henryk Grossman and Paul Mattick, the former having worked out a theory/model of capitalist breakdown first in 1919 and then in 1928-29, the latter building on Grossman with his 1934 The Permanent Crisis, and others thereafter.

    “the surplus value may absolutely increase, but it will nevertheless be insufficient for the needs of accumulation because the rising organic composition swallows an ever greater part of surplus value.” (4)

    The mass of value created in excess of that paid for may increase but not at the same rate as the total mass of capital that surplus value must valorize, or, the progressively higher capital:labor ratio comes into conflict with itself, resulting in a generalizing overaccumulation of capital.

    "At some point, the rate of profit would fall to such an extent that there would be too small a surplus to maintain the capitalists’ share for private consumption and it would have to be reduced annually. Further along the line, when the profit rate goes down still further, the surplus value would not even be enough to satisfy the investment requirements for both constant and variable capital, if the accumulation rate is to be maintained. It is at this stage that the model reveals the breakdown of capitalism. The inability of the system to fund the expansion of variable capital at the required rate must lead to a steadily increasing industrial reserve army. This means there must be a corresponding reduction of any further investment in constant capital. Insufficient labour means not all the surplus that should be invested in constant capital is actually worth being invested: in other words, there will be a surplus – an over-accumulation – of capital."

    As Mattick summarises the situation:

    “Surplus value flowing from the previously invested capital must therefore lie fallow, and there arises a surplus of idle capacity looking for possibilities of investment.” (5)

    The crisis brings forth over-production and saturated markets, both of which are themselves symptoms of inadequate levels of surplus value generation.

    As Mattick explains, this is not driven by the demand-side but reacts against it:

    "There is no lack of purchasing power with which to expand production, but no use is made of this purchasing power because it does not pay to expand production since expanded production does not bring in more but less surplus value than on the previous scale. ….there is produced surplus value part of which is intended for accumulation, but without any chance for such application. Thereby the stock of unsold means of production, of unsold goods in general grows….This leads to price cutting and limited operations of factories. Enterprises go bankrupt; unemployment grows.”

    Further, and this might light some bulbs:

    "The excess surplus value seeks a return without production: it is used for speculation or as credit. Hence is ushered in the age of fictitious capital, in which frenetic bursts of investment pump up prices to unsustainable values, eventually leading to implosion once confidence in the house of cards evaporates. Management of these becomes increasingly precarious…, and devolves onto state capitalist institutions."

    IOW, we have known 'which way we are heading' [and why] for, at minimum, 75 years – Bernanke et al think they can 'win' and that's understandable given the failed again and again and again, perfectly disconnected, theories [really ideologies] they rely on.

  12. RebelEconomist

    Good post DoctoRx; clear and informative. I shall not rush out and buy the book!

    Perhaps the existence of this book and the publicity it has been given are a sign of an underlying problem – that economics judges analysis more by who has written it than by the quality of its logic and supporting evidence. If the book contains as much assertion, bias and hype as your review suggests, it would not have received much attention if written by anyone less famous, while I am sure that many unfashionable analysts who wrote coherent predictions of a bust earlier this decade were dismissed as cranks. I had a taste of this myself in the central bank community in 2000 when I pointed out the unsustainability of the Fed's increasing willingness to lower interest rates to ever lower levels in response to financial adversity such as LTCM and the dotcom bust.

Comments are closed.