Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism by George Akerlof and Robert J. Shiller

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The Essence

Economics has long too often been based on models that lack bases for real-world application. It is even sometimes said that its normative claims make it more of a religion than a social science. Why the disconnect? It is in part due to the rigid models used to predict human behavior. Economics has long viewed humans as absolutely rational decision-making machines. Though science now teaches us that cognition and affect (reason and emotion) always interact. So it would be foolish be make a prediction in economics without considering some of the ramifications of emotional factors on decision making; this is the goal of the book. Akerlof and Shiller revisit John Maynard Keynes idea that psychological forces can partly explain why the economy does not behave as economist predict it ought to. This concept is otherwise known as Animal Spirits. Animal Spirits takes its place in history as part of a larger movement in economics towards models that better represent human nature. As behavioral economics blossoms, we will remember Akerlof and Shiller for reminding us that our emotions matter.

Animal Spirits Journal Entry Notes:

This is my book summary of Animal Spirits. My notes are a reflection of the journal write up above. Written informally, the notes contain a mesh and mix of quotes and my own thoughts on the book. Sometimes, to my own fault, quotes are interlaced with my own words. Though rest assured, I am not attempting to take any credit for the main ideas below. The Journal write up includes important messages and crucial passages from the book.

• Animal Spirits: It refers to our peculiar relationship with ambiguity or uncertainty. Sometimes we are paralyzed by it. Yet at other times it refreshes and energizes us, overcoming our fears and indecisions.
• We have long enough ignored the role of Animal Spirits. A description of how the economy really works must consider the Animal Spirits that do in fact exist.
• Saving in America is down… a lot. Why? Our devotion to the credit card is a factor. Shopping malls are symptomatic of broader views of who Americans think they are and how they think they should behave.
• Business thrives on the excitement of creating the future.
• Rededication to protecting the financial consumer must be one of our highest economic priorities.
• Context and point of view are crucially important in determining saving.
• Most economic up and downs are caused by overconfidence followed by underconfidence.
• Goods are much simpler commodities than labor.
• How the Fed can affect the macroeconomy?
1. Open Market Operations 2. Rediscounting.
• A great deal of what makes people happy is living up to what they think they should be doing.
• People have trouble think about broader feedback.
• Simple economic truths get lost in the heat of emotion.
• Echoing Keynes view of the role of macro policy…If there is a macroeconomic void the government must fill it. I must again set the stage for a healthy capitalism…The role of the central bank is to ensure the credit conditions that enable full employment.
• Non-cardholders have considerably higher financial assets relative to income.
• It is extremely easy to create group divisions.
• Government should encourage cues that enhance saving, as it should discourage cues that cause people to spend.

The Five Key Animal Spirits

Confidence
• The very meaning of trust is that we go beyond the rational. Indeed, the truly trusting person often discards or discounts certain information. Not acting rationally, but in accords to trust.
• Beyond the rational approach to choose.
• Low confidence has caused credit markets to freeze up, lenders do not trust they will be paid.
• Confidence, or the lack thereof, may be as contagious as any disease.
Fairness
• Consideration of fairness can override rational economic motives.
• When transactions are not fair, the person on the short end of the transaction will be angry.
• Equity Theory: it holds that on either side of an exchange the inputs should equal the outputs.
Corruption and Bad Faith
• The bounty of capitalism has at least one downside. It does not automatically produce what people really need; it produces what they think they need and are willing to pay for.
• People react to corruption and bad faith in financial markets by withdrawing...A way they believe to circumvent market failure.
• Culture change = Facilitates or hinders aggressively competitive or predatory activities.
Money Illusion
• Money illusion occurs when decisions are influenced by nominal dollar amounts.
• Going from nominal dollars to real dollars, something is lost in translation.
• Exact adjustment for inflationary expectations in wage bargaining is highly unlikely.
• We must merely recognize that capitalism must live with certain rules.
Stories
• Stories and storytelling are fundamental to human knowledge.
• It not only serves to communicate information in a form that is readily absorbed, but it also serves to reinforce memories related to stories.
• Politicians are one significant source, especially about the economy. They spend much of their time talking to the public. In doing so they tell stories. And since much of their interactions with the public concerns the economy so also do these stories.
• Stories no longer merely explain the facts; they are the facts.
• Stories are like viruses.

Reading Recommendations

If you liked what you saw. Here are 3 titles that I recommend based on what was discussed in Animal Spirits.

1. Irrational Exuberance by Robert J. Shiller 
2. Freakonomics: A Rogue Economist Explores the Hidden Side of Everything bySteven D. Levitt and Stephen J Dubner
3. Misbehaving: The Making of Behavioral Economics by Richard Thaler

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