Book Review: Animal Spirits by George Akerlof and Robert Shiller

Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism‘ provides an insightful and critical analysis of traditional economic theory and explores the application of behavioural economics to the current global economic crisis.

In the first part of the book, Akerlof and Shiller describe animal spirits as ‘non-economic motivations’. The psychological and even irrational elements that figure importantly in so many other familiar aspects of personal choices and personal behaviour, and that, they argue, pervade economic behaviour too. These five elements of ‘Animal Spirits’. First, and most important element, confidence, or the lack thereof. Secondly, fairness, in terms of how people believe that they and others should behave. Thirdly, corruption and other tendencies towards antisocial behaviour. Fourthly, money illusion, meaning susceptibility to being misled by purely nominal price movements that, because of inflation or deflation, do not correspond to real values ‘stories we tell ourselves,’ and outline why the presence of these behaviours leads to failures in market capitalism. Final element is stories or rumours, positive or negative, in the financial market. The authors argue that, because human behaviour is influenced by animal spirits, humans do not behave rationally; and so economic theories fail to incorporate human behaviour accurately due to their neglection of these Animal Spirits, causing multiple assumptions made in their structure. As a result, the most conventional of economists are blocked from both understanding the modern day’s economic crisis or providing significant ideas for dealing with it.

The second part of the book illustrates how these irrational animal spirits affect economic decisions by answering eight questions that deal with various economic failures. The authors provide clear explanations and extensive documentation so that a general audience with an interest in economics can stay engaged. Given current levels of economic upheaval, this book will be easy to engage an audience. The evidence that human psychology drives the economy is persuasive and provides the reader with an alternate perspective on the modern day economic crises. The authors provide a broader view of economics than the ‘cold economic calculus’ that economists think should be at the centre of all economic activity and reasoning. This book is important and useful in understanding some of the limitations of the economic theory of rational expectations. Incorporating animal spirits into macroeconomic theory is an improvement because it provides a more realistic portrayal of the world.

As Akerlof and Schiller outline flaws in widely accepted economic theories, it could seem that the authors are arguing against capitalism. However, they make it clear in the book that they are against unfettered capitalism. Following John Maynard Keynes, they recommend government intervention in the economy. In particular, they state that government should “set the conditions in which our animal spirits can be harnessed creatively to serve the greater good.”

The book challenges economists to extend analysis to include more realistic assumptions about human behaviour. While the recommendation has significance, the book fails to provide enough detail explaining how to account for animal spirits in modelling human behaviour, and so how to improve decision making. While it is worthwhile to explain behaviours that cause traditional economic theories to fail, it is important to incorporate the variables into models in order to improve predictive ability and lead to better decisions and policies. However, because animal spirits are not easily categorised and quantified, the effects are often not clearly foreseeable until hindsight. This could make it impossible to include them in traditional mathematical models. Thus, the challenge then that this book poses to the modern day economist, is figuring out how to include animal spirits in decision-making models. A task that requires an understanding of society outside of economics that encompasses other forms of social study. In this way, the reader is left questioning how this might be done.

Akerlof and Shiller state explicitly that they do not provide detailed answers to specific questions about dealing with the today’s global economic crisis. Instead, they call for an understanding of animal spirits and a realisation that markets require government involvement in order to prevent such crises from happening again. This book provides ‘the background story’ from which policy makers need to move forward. While it seems clear that government involvement is required, it is also important to keep in mind that government committees and commissions are also made up people who possess these animal spirits. This aspect of animal spirits should be included when constructing new models of decision making rather than being left out of their discussion.

To conclude, the book, ‘Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism‘, should be read by anyone who seeks a clearer understanding of human behaviour and how it affects the economy. More people would perhaps find the study of economics interesting if the theories were based on more realistic assumptions. If this leads to more accurate predictions from economic analyses, it would be invaluable in preventing future economic crises.

Contributed by Alex Williams-Baffoe

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