Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism.

• Author: Gokhale, Jagadeesh
• Position: Book review

Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism

George A. Akerlof and Robert J. Shiller

Princeton, N.J.: Princeton University Press, 2009, 264 pp.

Probability theory suggests that large numbers of independent economic agents should lead to greater macroeconomic stability. The likelihood that economic outcomes would deviate from their true central tendencies should decrease as the number of economic decisionmakers increases. The United States and many other economies have many millions of such decisionmakers. So why do large economic business cycles occur?

Many economists have offered answers to this question. Perhaps market actors alternately face good and poor economic choices because of external macroeconomic shocks; perhaps their decisions and interactions are dominated by herd behavior; and perhaps their actions are sometimes driven by nonrational motives that steer them far from normal levels. During the Great Depression of the 1930s, J. M. Keynes dubbed the last of these explanations "'animal spirits." The book by professors Akerlof and Shiller is an attempt to dissect that term and expose its core content and meaning.

The subject of "animal spirits" lies at the heart of maeroeconomics. With a recession underway as backdrop, the book's discussion about the roles of market institutions and governments is highly topical. And the authors are renowned economists, particularly in the subfields of labor and financial markets. Both are credited with a deep understanding of economic history, the history of economic

thought, and today's global economic environment. That makes this book a "must read" for anyone seeking insights into recent economic events and seeking ways of crafting government policies to prevent another similar economic downturn.

Markets versus Government

The book presents two contrasting paradigms: free markets and socialism. Under the former, government intervention is minimal with the expectation that the "invisible hand" of private rational decision-makers will work successfully to equilibrate markets and maintain macroeconomic stability. Under socialism, government intervention is at its maximum--with the government owning and operating productive enterprises. The book argues that free-market systems are likely to pursue excesses eventually leading to distress and turmoil. Such systems are unlikely to experience prolonged economic stability. At the other extreme, socialist states are likely to stifle citizens' creative activities and reduce economic growth.

According to the Akerlof and Shiller, the government should play a paternal role. It should provide an optimal economic environment--with just sufficient intervention to create a "happy home" within which the private-sector "child" is free to be creative but with little chance of its own "'animal spirits" posing a danger to its well-being.

The authors complain that Keynes' identification of "animal spirits" as the cause of economic fluctuations was suppressed in the pedagogic cramming of Keynesian economics into the straitjacket of classical economic analysis to facilitate its understanding. That made easier the resurgence and dominance of the new classical doctrine for three decades after the 1970s. The current economic crisis is the result of allowing markets to "become drunk,"...