Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism (Unabridged) [Audio Download]

Nobel laureate George A. Akerlof and prescient Yale economics professor Robert J. Shiller explain the role of human psychology in markets. They say conventional economic theory assigns too much weight to the role of reason in economic decision making, and too little to the role of irrational emotional and psychological factors. That insight would have been novel a few years back, but numerous other authors have made the same point, though few with such sterling credentials. Having asserted their beliefs and offered evidence about the power of emotions, or "animal spirits," the authors prescribe curative policies though they don't always illuminate their proposals' full real-world impact. Akerlof and Shiller's distinguished reputations command attention, and getAbstract confirms that their book is worthwhile reading. Yet, those who know the authors' bodies of work may wish for even more insight.

A reformation is the restoration of a system of thought to the purity of its original ideas. The Keynesian Revolution in economics of the 1930s departed from the economic orthodoxy of its time partly by stressing the importance to the economy of emotional drives - "animal spirits" . Arkelof and Schiller describe how Keynesian economics was emasculated by the relegation of animal spirits to a minor role, in an effort to make it more palatable to classical economists . The authors argue there is now sufficient evidence to prove the importance of animal spirits beyond doubt, and the resulting re-invigorated Keynesian economics should be sufficient to encourage and legitimise government policy makers to implement measures of sufficient boldness to get us out of the current economic crises. I summarise the ground covered in this book in more detail in an article on wiki.

This book is written in a clear and accessible style, and should appeal to the general reader seeking to understand the reasons for the current financial cries, or just looking to deepen their understanding of the economy in general. The authors extol the virtues of the free market and are against excessive government control, but they make a powerful case for more robust intervention than has been fashionable in western economies for the past few decades. I hope this book is widely read by both policy makers and economists, and has the desired effect in boosting Keynesian influences on political decision making so the current crises can be quickly contained and replaced by a more stable and fairer economy.

I have a few concerns about the books style and lack of polish. The preface is bold and compelling, yet most of the following chapters lack energy and rigour. Its easy to see it was written more than a year back when the neoliberal view point was orthodox, and thus the authors did not feel entitled to argue as confidently as they might today. Shiller in particular is entitled to speak with authority as he was one of the few prominent economists to speak out strongly in favour of Keynesian solutions in the crucial early months of 2008, where if the then still strong free market orthodoxy had not been driven back we'd be in a far worse state than we are now (see my wikki article on the Keynesian Resurgence) While the frequent use of stories to support their positions makes the book a quick and easily digestible read, it would have been greatly strengthened by less sparse use of numerical data and charts, and especially by greater references to the work of others in behavioural economics and other relevant areas. I like authors to often use the feminine pronoun instead of the traditional masculine or the clumsy he / she , but its jarring when they do it all the time and if one's going to feminise 'joe public' , is it necessary to use Josepha rather than the cooler Jo or the more pleasing Josephine? Well perhaps the authors know best how to pitch the book to persuade their fellow Americans, and they felt the urgent need for their message justified rushing to publicise. I hope they will soon release a second edition which will at least be more generously referenced. The message is spot on, I hope the presentation is sufficiently strong for the book to have the revolutionary effect it deserves to.

This is a very timely book. It seems that we are at a bit of a turning point in terms of economic ideas, and a more behaviourally-informed view of the world looks likely to become more prominent. The book is also very of the moment as it is pitched as in part sketching out a behaviourally-informed Keynesianism (the term 'animal spirits' being used in the General Theory).

It is basically split into two parts - the first section runs though some key concepts that affect behaviour, and the second applies these concepts to a number of issues. The concepts that the authors highlight are confidence, fairness, corruption and bad faith, money illusion and stories. All of these are important factors as they show how human decision-making is not necessarily rational and self-maximising.

Just to take a couple of examples from this list, Akerlof has been involved in some very interesting research into how conceptions of `fairness' affect market behaviour. Although it might be assumed that we are only motivated by our own interests, and fairness doesn't really matter to us, actually `unfair' behaviour can make (some of) us want to negatively reciprocate (retaliate), and willing to sacrifice our own potential gains in order to punish those acting unfairly. This has obvious implications (as Akerlof has argued previously) in terms of employment relations.

I was also very interested to see stories as one of the factors that they identify. This is a key part of Shiller's analysis of bubble psychology too (the stories we tell each other about what is going on act as positive reinforcement/feedback). As a contemporary example of a story that has given validity to a certain type of activity, think about the number of people using the argument `my house is my pension' as a way of explaining/justifying their punt on property investment. Actually this section of the book is pretty short, which is a shame as I think there's a lot more in this issue.

Turning to applications, Akerlof and Shiller look at a number of policy areas where a behaviourally-informed view of economics might shed some light. Whilst often behavioural economics has appeared to have most to say about individual activity, Akerlof and Shiller are much more ambitious here, and tackle some big issues - why do economies fall into depression, why can't some people find a job, why are market prices and company investments so volatile, why do we get property bubbles etc?

So, for example, the section looking at depressions they not surprisingly put a lot of emphasis on the collapse of confidence. Confidence and the lack of it something that is, of course, widely talked about in terms of economic performance, but hard to quantify. However a review of press reports at the time of the Great Depression illustrates how common a theme it was (especially the need to boost confidence). Akerlof and Shiller also make the point that 'confidence' itself is a 'multiplier', having a reinforcing effect both when it is positive and negative.

The chapter on the volatility on financial prices is one of the ones that interested me most, as it brings together a number of strands explored earlier in the book. Obviously during an asset price bubble you can see a number of factors at play. As prices go up more people are drawn in, pushing prices up further. People then rationalise the bubble through stories (the internet has changed everything, there's a shortage of building land etc), they also get taken in by money illusion when hearing about appreciation in, say, house prices (something those involved in flogging houses are not keen to puncture). In all this to me provides a much more believable explanation of what goes on in terms of asset prices than much professional market commentary.

It's worth making the point here that Akerlof and Shiller are really calling for a bit of a new direction in economics, paying more attention to these kinds of social/psychological factors. This doesn't (need to) require junking existing approaches, as some of this stuff could be grafted on, however they seem to favour quite a shift. Whether there is enough in behavioural economics to bear the weight of such a transformation is a bit of an open question I guess.

Finally a bit about the style. In general, the chapters are fairly short and overall it has a very non-academic feel. Whilst that's a plus point in general, you do wonder whether this might make it seem a bit flaky (which it isn't) to some readers. Sometimes it does feel as if they could have gone into more detail. Hopefully the accessible style won't lead people to assume the ideas expressed are lightweight. This is definitely well worth a read.