Customer Reviews: Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism
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on May 26, 2009
Economists, in pursuit of mathematical precision, seem to have forgotten that not everything can be easily counted. Traditional economic theory centers on the premise that people make perfectly rational decisions. People, however, are not so rational. Despite many attempts, not every variable that goes into our decision-making process can be easily quantified, weighted, and stuffed into a formula. As any non-economist knows psychology -- and its hard to measure variables -- plays a large role in how people make decisions.

George Akerlof and Robert Shiller's book, Animal Spirits, offers an accessible look at how traditional economics can be expanded by incorporating some basic concepts from psychology. The term "animal spirits," originally coined John Maynard Keynes in the 1930's, describes how impulses and emotions naturally lead to economic boom and bust cycles. Traditional economists seem to have ignored even the most primitive of these spirits.

Economists create impressively complex formulas attempting to accurately describe the state of the economy and predict future trends. However, there are just too many unquantifiable variables - feelings, emotions, intuition, and confidence- to accurately incorporate all available information into a simple neat equation. Incorporating psychology into economics may not sound like much of a breakthrough. But Akerlof and Shiller have stepped outside of current economic thought to gently nudge animal spirits back to the discipline.

The first part of the book offers five examples of animal spirits: confidence; corruption; money illusion; stories; and fairness. While there are many more psychological factors at work in decisions, these offer a step in the right direction. A quick look at the internet bubble shows how these spirits can unknowingly influence our decisions.

In the late 1990's, investors were confident in a "new economy" and drove the price of internet related stocks up far more than a reasonable estimation of their economic prospects would justify. As the stock market increased in value, we entered a positive-feedback cycle from our investment decisions that further increased our confidence. As confidence rose so did the markets. In the end, we all know how this cycle turned out.

In the second part of the book Akerlof and Shiller answer some big questions calling attention to the role of the animal spirits. Why do economies fall into depression? Why is saving for the future so arbitrary? Why is there unemployment? Why are financial prices so volatile? Why do real estate markets go through cycles? Why is there special poverty amongst minorities?

The book offers persuasive, well-researched, prose that challenges the conventional wisdom that underlines much of existing economic theory. In attempting to answer some large fundamental economic questions by calling attention to psychological influences, the book offers a first glimpse of what economic solutions might look like in the future.
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on July 16, 2009
Let me edit my review slightly. Please notice the first words of my original review: "Given such accomplished economists." I don't think it's unreasonable to hold these authors to a very high standard. Because I know that they could have done a much better job of organizing their thoughts, and given the stakes involved at an early stage in the development of financial crisis when policy makers were in dire need of good advice, I was very critical. Consider this - in a book on "Animal Spirits" there is very little on entrepreneurship! BTW Keynes did not originate the term, and Adam Smith was not an uncritical apologist for capitalists. Milton Friedman was not a blind apologists for corporations, and Ronald Reagan was not as radically free-market as people these days think. Gosh, how many times do these things need to be said?

Given such accomplished economists, and being sympathetic to behavioral economics I expected better from this volume. The book has obviously been rushed to print. There are numerous errors. Just to give a few examples:

They present Adam Smith as the father of the rational economic man model when in fact he was the author of "The Theory of Moral Sentiments" (a masterwork of psychology) and certainly never claimed that emotions did not matter for economics.

They present Keynes as having "animal spirits" at the center of his theories which is not true. They do not even give the background to the phrase, which was more than two hundred years old at the time Keynes wrote.

They completely misrepresent the work of Milton Friedman generally and with respect to the Great Depression specifically. They even get his ideas about money illusion wrong. They seem hopelessly confused about the difference between Friedman and the later "rational expectations" theory. In fact there is surprisingly little about modern macroeconomics including modern Keynesian thought.

Did they even read Friedman's great work on the Monetary History of the United States? They make a single reference in passing to it in the text. It is extremely meticulous in tracking the events of the Great Depression. Even J.K. Galbraith highly praised it as a work of empirical research.

Although they discuss bubbles and speculation the general reader would finish the book with no idea that experimental economists have been replicating and studying these phenomena in the lab for over 20 years and have discovered many things about what contributes to them. This is part of the authors' pattern of setting up mainstream economics as a straw man with no concern for psychology.

A more fundamental flaw is that they never make a persuasive case that animal spirits are the core of the problem. Yes there are many historical anecdotes and stories - but there is no overall scheme or theory in this book. It's a mess of disconnected thoughts, stories, anecdotes etc..

On a final note, there is a degree of condescension to the general reader which is quite irritating. For example, in discussing poker in the introduction we are informed that players often try to deceive their opponents and this is called ... "bluffing." (!)

In summary, a book that was rushed to market.

An addendum - just happened to pull the book off my shelf in July 2012. Was I too harsh before? I opened a chapter at random. Chapter nine - the authors try to argue that Friedman was wrong about there being no long run inflation/unemployment tradeoff. Somehow, in all this chapter, they manage to never once reference the ruinous stagflation of the 1970s! Instead they want to fuss about the difference between a 1.5% inflation target rate vs. a 0% inflation target rate. They invoke a lecture by Paul Samuelson - in 1964. Let me contrast that with Keynes biographer Robert Skidelsky in "The Return of the Master": "Milton Friedman predicted the coming of simultaneous increases in inflation and unemployment - so-called stagflation - as early as 1962." Even the most Keynesian of Keynesians agrees that at least on this one point Friedman had it right. No, I was not too harsh.
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on March 25, 2009
"Animal Spirits" is an important contribution to rethinking economic theory, particularly macroeconomic theory, so that it better takes account of human irrationality.

The central argument of the book is that various human emotions - overconfidence, unwarranted pessimism, a sense of fairness, and stigma effects - can have important aggregate effects on the economy. Economists have often tended to overlook these factors, for several reasons: the irrational is difficult to model, and it has sometimes been assumed that these "irrationalities" will average out or be weeded out by the market. But Akerlof and Shiller argue that frequently such "animal spirits" can result in self-reinforcing cycles of either boom or bust. Irrationality is not only not tamed by the market, but can even be reinforced.

Akerlof and Shiller consider varied topics in this book, including determinants of savings rates and wages, and high African-American poverty. However, most of the book focuses on how "animal spirits" might help better explain the business cycle. Their book is opportune, as the current downturn is plausibly explained as the result of the excesses of an unregulated speculative fever in housing and related investments. Their book includes a valuable postscript to one of the chapters that analyzes possible responses to the current financial crisis.

I think this book is best suited to an audience that is reasonably well-aware of economic ideas about markets and the macroeconomy. This of course includes professional economists as well as many policy wonks interested in macroeconomic policy. It would also be a valuable corrective for a wider audience that holds the belief that the market is always in the aggregate efficient. This book supplies one more valuable argument for some government intervention in the market: the need for regulation to discourage various sorts of speculative bubbles.
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on March 13, 2010
The main idea of this book is that, when it comes to economics (both micro and macro), individual and group psychology matters a lot. This means that economic models based on assumptions of rational agents and efficient markets are incomplete at best and misleadingly inaccurate at worst.

Akerlof and Shiller propose five key psychological factors, the most important being confidence (or lack thereof) in the economy and one's personal place in it. The other four factors are perception of economic fairness, perception of corruption (and actual corruption!), understanding of the effects of inflation (money illusion), and the narrative stories we tell in order to interpret our economic past, present, and future. The effects of all of these factors are generally amplified by feedback processes. I believe the authors are essentially correct in their analysis. After all, if you have bad feelings about the economic situation, you'll be reluctant to consume and hire. When a lot of people feel the same way, aggregate consumption and hiring will drop, and a drop in aggregate production must follow.

Akerlof and Shiller next apply these factors in order explain why depressions occur, how central bankers can influence the economy, why unemployment occurs, why people don't save properly, why investments are volatile, why real estate markets go through cycles, why poverty is more common among minorities, and, most pressing, what should be done about the current financial crisis. In this last regard, their answer is that the government must actively restore confidence and a sense of fairness, regulate markets to control corruption and prevent bubbles and busts, and manage banks to ensure adequate supply of credit. I agree, and this is largely what the Obama administration is doing, though they need to do more of it.

My main criticism of the book is that, while the writing is elegant and engaging at the level of sentences and paragraphs, the writing is somewhat unfocused and repetitive at the level of sections, chapters, and the overall book. This reduces clarity and unfortunately obscures the chains of reasoning in the book. A lesser criticism is that the authors apparently don't realize that Adam Smith was aware of most of the factors they mention and the consequent need for government intervention; the problem is that those who have appropriated Smith's ideas have ignored those aspects.

Nevertheless, the bottom line is that this is an important book because it offers an accurate diagnosis and sensible solution for our current economic problems, so I recommend it, especially to people involved in formulating and implementing economic policy.
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on June 29, 2009
I am a retired engineer who worked on many problems of system dynamics. I am not knowledgeable about the field of economics as are most of the reviewers which I read. I was motivated to read "Animal Spirits" mostly because of my disgust at the Adam Smith-Milton Friedman blind adherence to the concept that "markets are self-correcting" and I wanted to read how two outstanding economists would show how human actions can destabilize the system. Alas, I was disappointed. The book is worth reading, but I did not find it an easy read. Partly, it was because of my unfamiliarity with the vocabulary of the economists, and partly because it droned on and on, saying the same things in different ways, which is so typical of these types of books. What shocked me, though, was that, although the authors spoke several times about "feedback," the word "stability," or variations thereof, did not occur once in the 176 pages. A function of several variables can be well-behaved over most of its range, but have singularities where the function goes to infinity. Conversely, a function may be mostly unstable, but have small ranges of stability. An analogy of the latter would be the classic example of the marble carefully balanced at the top of a convex surface. Any small disturbance which moves the marble, however imperceptibly, away from its balanced position causes it to depart ever more from that position. However, now consider that there is a small depression at the top of the convex surface. Within that small region, the system is stable and the marble will return to the center. Adam Smith prevails! As long as all is at or close to equilibrium, and there are minimum external disturbances, people behave in a rational manner and the system is self-correcting. But if there should be an input that pushes the marble past the depression, it will move ever away from the middle. When it has not gone too far, small corrective forces can stabilize the system. The actions by the Fed in adjusting credit and money supply were quite effective when the system was not too far from equilibrium, but when "irrational exuberance" took hold, the system became vulnerable to corruption or financial chicanery. An analogy for human reactions which drive the system to extremes, up or down, is the ouija board. Everyone puts their fingers lightly on the planchette to follow its movements as if caused by some supernatural force. Some little disturbance causes it to move and everyone follows, they think, but they are really pushing it in concert to the edge of the board. Akerlof and Shiller, following Keynes, call it "animal spirits." But it is just the natural herding tendency of many types of living things. Another good analogy for the economic system is the broomstick, which one can easily balance on a fingertip. When it is near balance, it is easy to control it with small motions of the hand (actions of the Fed). When it starts to fall, it takes violent corrective motions of the hand to catch it and restore balance (stimulus programs). If these fail, the broom falls to the ground -- the system collapses (The Great Dpression). It is unfortunate that Akerlof and Shiller did not pull their argument together at the end and make the point that animal spirits in their feedback effects act to destabilize the system. Some form of controller must be employed, whether by private or governmental action. See the article by Brian Hayes, "Everything is Under Control," in the May/June 2009, issue of American Scientist. Akerlof and Shiller make good points on multiplier effects, but never brought out the fact that credit is the multiplier for liquid cash and is an inherent part of the "plant," as the control-system designer calls it, the operating element of the economic system which converts materials and labor into useful outputs. Credit is the amplifier and, as everybody knows from squealing public-address systems, excessive amplification can cause instability. Excessive credit has been noted by many writers as one of the causes of current (June 1009) difficulties. Akerlof and Shiller seem to give up on the possibility of treating animal spirits in any quantitative way. I suggest that much could be done by further research on this topic. And, to add another engineering thought, to find ways to just slow down the pace of transactions in proportion to the magnitude of recent changes, a mechanism which would be the equivalent of adding damping to an oscillating system.
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on June 20, 2013
First, Akerlof and Shiller are two first-rate economists. The first for his classic illustration of the market for lemons that won him a Nobel Prize for the concept of asymmetric information; the second for his excellent work on risk sharing and macro-markets that may yet score him a Nobel.

Unfortunately, this book falls far short of that promise. They've squandered an opportunity to make a clear case for incorporating behavioral economics and finance into macroeconomic theory and policymaking. There are several good critiques on these Amazon pages, so I will avoid redundancy, but behavioral economics at the macro level can be distilled down to prospect theory and the realization that rational economic agents are loss averse, adaptive and heterogeneous. In other words, we react to perceptions of risk, uncertainty, confidence in, or fear of an unknown future. Policy directly affects real economic fundamentals that influence these perceptions that determine the resultant level of risk-taking. But the perceptions themselves are not the tail that wags the dog - it is the real measurable effects of policy outcomes. Current Fed policy is a case in point: showering cheap liquidity on financial markets in an attempt to revive false confidence. What we get are volatile asset markets, inadequate productive investment, scant job creation, and sub-par wealth creation. The policy has also seriously aggravated economic inequality.

Instead of cutting to the chase, A&S water down their explanation of animal spirits with nebulous concepts of fairness, corruption, money illusion, and stories. Are they strictly wrong in this approach? No, just beside the point. Most notably, fairness does not have a clear political definition, though it does have a moral and economic one: consequence follows action. This moral rule is reinforced by the history of our legal and judicial system, under which corrupt politics and "heads we win, tails you lose," banking is in clear violation. (BTW, political corruption includes all those government regulators captured by their regulated industries.)

Misguided policies have gotten to where we are and both laissez faire advocates and neo-Keynesians bear responsibility. By the end of the book it seemed like A&S's hasty polemic did not argue well for behavioral economics as much as try to soft sell the policy prescriptions of the New Keynesian school. But those policies have gotten us nowhere in terms of correcting the mistakes of the past. Lastly, A&S would be wise to note that our country already has a very good story that we seem to have forgotten: work hard, follow the golden rule, save, and invest prudently in a promising future. If we all did that, we wouldn't have these problems.

Political Economy Simplified: A Citizen's Survival Guide
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on September 13, 2009
I was deeply disappointed by this book. I was truly surprised by the lack of any academic standards and lack of thoughtfulness. There are many ideas here but none are well thought out and they are not put together in a cohesive theory, nor is there any attempt to prove them using well available data. For instance: the authors seem to be stomped by peoples refusal to have their wages lowered during deflationary times and they suggest that this is due to the money illusion. However, is it not obvious that deflationary wages increase ones debt burden? They also seem to suggest that corruption is one of the causes of depression. Why not test this idea by looking at historical data on corruption (There is plenty available) and plot that against GDP growth? I was also surprised that leverage and debt were not once mentioned in the book, even though the book attempts to explain the origins of depression (Then meander off to other topics).
I do not recommend this book.
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on June 12, 2013
I enjoyed "Animal Spirits" immensely. It is written in a very accessible manner, without an excess of economic and financial jargon.

The book's interest is the emerging study of behavioral economics. The book is a wonderful overview, if not detailed, account of the reasoning behind behavioral economics.

The authors introduce the key concepts of behavioral economics in five chapters at the beginning of the book. These concepts are Confidence, Fairness, Corruption, Stories and Money Illusion. The authors then follow these first chapters with additional chapters that explain in greater detail how these human behaviors affect the market. Messrs. Akerlof and Schiller, in essence, describe how human behavioral processes construct the functioning and understanding of the economy.

Messrs. Akerlof and Schiller give John Maynard Keynes the recognition and esteem his genius so deserves. In fact, the books name is derived from a Keynesian term. The authors make it clear that Keynesian economic logic has an intuitive understanding of "how the world works". The book explains that Keynes work portrays an innate understanding that economic decisions are directed more by an individuals emotions and immediate pragmatic concerns than by Adam Smith's delusional concept of "enlightened self-interest".

I was surprised to learn that some governments were timid about embracing Keynes ideas more fully, since Keynesian concepts are based more on observation than traditional economic "thought". After all, Keynesian economics and labor unions built the middle class in this country and in Western Europe.

My only complaint is that the authors, as most economists of any school do, somehow find the faith to believe that Adam Smith and his cohorts were somehow fundamentally correct. When studying Smith, Jeremy Bentham, Francois Quesnay and other Classicists, whether of the 18th century or now, a natural skepticism should arise. An adequately skeptical person will realize that classical economic thought is awash with unproven and unprovable assumptions and magical thinking.

Despite my complaint, the authors do understand that, as Thorstein Veblen stated in 1898, "economics is hopelessly behind the times". The understanding of the real world reflected in this book gives hope that those such as Messrs. Akerlof, Schiller, Ariely, the Keynesians and many others will lead economics away from the shamans and wizards to which economists now so tightly cling. The behavioral sciences will create a new economic paradigm in which economics may become an actual science and not the mere scientism it is now.

Neo-liberal economists will be surely be pulled, kicking and screaming, from the darkness in which they have existed for some 400 years. Economics may just finally bathe in the light that has shown on all science and finally join the 21st century.
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on June 28, 2009
Laced with examples and stories of how "Animal Spirits" impact our economy, this book is an enjoyable read. The authors' main point is that the study of economics, as taught in universities, focuses too much on just the numbers and graphs and dismisses the "thought patterns that animate people's ideas and feelings, their animal spirits." Chapters on confidence, fairness, corruption and bad faith make many good points about how impactful these are on the economy and how, overall, our emotions lead us to decisions that the numbers might not say are rational.

These are excellent points. However, the book doesn't quite do the job of pulling everything together as convincingly as it might. It goes overboard in many ways without substantiating its arguments. The authors say that they started writing the book in 2003, but it read more like it was thrown together and rushed out the door to sell in our current economic environment.

As a quick aside, the title might seem a little odd to someone not familiar with "Animal Spirits". The term comes from John Maynard Keynes, a well known economist from the 1930's, whose writings are the basis of Keynesian Economics. Many current economists base their viewpoints on Keynes' concepts, particularly when arguing for support of the stimulus package. In any case, in his famous 1936 book The General Theory of Employment, Interest and Money, he used the term "Animal Spirits" to describe the thought patterns mentioned above. Now the term "Animal Spirits" is widely used in economic circles when discussing emotion and its affect on human behavior.

One of the best chapters in the book is on Money Illusion. Money Illusion occurs when people don't take into account the real, or relative, value of things. Instead they only look at the nominal value when making their decisions. In plain English, this means that people forget about the impact of inflation when making purchasing, investment, salary or other decisions. . I see examples of this every day when talking to clients and colleagues. Akerlof and Shiller make the excellent point that since the 1960's the concept of Money Illusion was driven out of mainstream macroeconomic thought.

The authors don't support all of their arguments well and I don't agree with all of their arguments in this chapter. For example, they argue that, without Money Illusion, mortgages would all be indexed somehow to inflation; but they are ignoring one's need to have the certainty of fixed payments for planning. Since one cannot know how things will be adjusted in the future, they opt for a fixed payment stream. This does not necessarily imply that Money Illusion is involved in the decision (although it certainly may be in some cases). They take their argument too far here.

Page 173 spells out, in a fairly clear manner, the authors' political points of view. "Without intervention by the government the economy will suffer massive swings in employment. And financial markets will, from time to time, fall into chaos." I find this selection stunning in what it leaves out. Government involvement in the Great Depression clearly caused tremendous swings in employment and amazingly large moves in the financial markets. To say that government will prevent them strikes me as surprisingly naïve. I do believe we need to change how and what we regulate, but throughout the book the authors seem to suggest government involvement as the panacea.

Clearly, the capital markets need some rules and regulations under which to operate, and those areas with lax or no regulations (i.e. credit default swaps) contributed greatly to the economic position we're in. However, the book goes overboard in its recommendations of government regulation and control without sufficient support for its argument.

Apparently this book has been read by some of the top policy makers in the Obama administration. I hope that the issues the book raises with respect to "Animal Spirits" are reflected in their policy, while many of the solutions presented in the book are not.

Overall, this is a fairly easy and quick read, and although I'm rating it only 3 stars, I recommend it for the layperson with an interest in economics and in looking at some of the reasons for the situation in which the U.S. -- and the world -- find themselves. My caveat is that, should you choose to read the book, you are very careful in accepting the authors' solutions to solving our economic issues.
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on February 20, 2009
This book covers a number of important topics that are lacking from modern macroeconomic theory, and has come out at a time when interest in the problems with modern theory has reached a fervent pitch. Sadly though, the book is short, very unevenly written and clearly rushed to press in order to meet a new demand for answers as to why our economy is ruled less by logic than by the psychological complexities of individual people.

These criticisms are all the more interesting given that in their acknowledgments, the authors note that drafts of the book were used for the last 5 years as textbooks for a class at Yale. Surely there was enough interest in the psychology of markets, and time to finish the book, before the current crisis began.

Is the lesson to learn here that even economists who want to improve their field suffer from a laziness that permeates academia, and leads to such poor modeling to begin with?
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