Animal Spirits

Akerlof and Shiller borrow John Maynard Keynes's phrase for the restless, non-economic motives behind investment and use it to explain what standard macroeconomics could not. They name five animal spirits: confidence, the most important, which feeds on itself and turns optimism into booms and fear into slumps; fairness; corruption and bad faith; money illusion; and stories, such as the belief that house prices always rise.

The authors have the standing to make the case. Akerlof shared the 2001 Nobel Prize for his work on markets with asymmetric information, and Shiller, author of Irrational Exuberance, had warned about both the stock and housing bubbles; he went on to share the 2013 prize. Written as the crisis unfolded, the book argues that government must act decisively to restore credit and confidence, and it criticizes the faith in self-correcting markets and rational actors that had come to dominate economic thinking.

Clive Crook in the Financial Times called it the right book at the right time, Louis Uchitelle in the New York Times called it a milestone, and it was shortlisted for the Financial Times and Goldman Sachs Business Book of the Year award. The main dissent came from Richard Posner, who attacked it at length in The New Republic. Readers should know that it argues by example and history more than formal evidence.

It is a useful bridge between behavioral finance and macroeconomics.

1. Confidence has multipliers. Shifts in confidence change spending and lending, which change incomes, which change confidence again, amplifying cycles.
2. Stories move markets. Narratives such as the idea that home prices never fall can drive prices and investment far from fundamentals.
3. Money illusion is real. People resist nominal pay cuts and think in nominal terms, which shapes wages, debt and asset prices.
4. Booms breed bad faith. Corruption grows in good times, and its exposure can turn a downturn into a crisis of trust.
5. Policy must address psychology. The authors argue that restoring confidence and credit is as important as setting interest rates.

The book has two parts, followed by a conclusion; the 2010 paperback adds a new preface on why the slump could persist.

1. Introduction. The authors set out Keynes's idea of animal spirits and argue that economics went wrong when it dropped psychology from its models of the business cycle.
2. Part One, the five animal spirits. Separate chapters explain confidence and its multipliers, fairness, corruption and bad faith, money illusion, and stories, each with historical examples from past recessions and booms.
3. Part Two, eight questions. The authors use the five spirits to answer why economies fall into depression, why central bankers have power over the economy, why some people cannot find jobs, why there is a long-run trade-off between inflation and unemployment, why saving for the future is so arbitrary, why financial prices and corporate investment are so volatile, why real estate markets go through cycles, and why poverty persists among minorities.
4. Conclusion. They apply the analysis to the 2008 crisis and argue for a large stimulus and direct action to restore credit flows and confidence.

The global financial crisis has made it painfully clear that powerful psychological forces are imperiling the wealth of nations today. From blind faith in ever-rising housing prices to plummeting confidence in capital markets, animal spirits are driving financial events worldwide. In this book, acclaimed economists George Akerlof and Robert Shiller challenge the economic wisdom that got us into this mess, and put forward a bold new vision that will transform economics and restore prosperity. Akerlof and Shiller reassert the necessity of an active government role in economic policymaking by recovering the idea of animal spirits, a term John Maynard Keynes used to describe the gloom and despondence that led to the Great Depression and the changing psychology that accompanied recovery. Like Keynes, Akerlof and Shiller know that managing these animal spirits requires the steady hand of government--simply allowing markets to work won't do it. In rebuilding the case for a more robust, behaviorally informed Keynesianism, they detail the most pervasive effects of animal spirits in contemporary economic life--such as confidence, fear, bad faith, corruption, a concern for fairness, and the stories we tell ourselves about our economic fortunes--and show how Reaganomics, Thatcherism, and the rational expectations revolution failed to account for them. Animal Spirits offers a road map for reversing the financial misfortunes besetting us today. Read it and learn how leaders can channel animal spirits--the powerful forces of human psychology that are afoot in the world economy today. In a new preface, they describe why our economic troubles may linger for some time--unless we are prepared to take further, decisive action.