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The ANIMAL SPIRITS: conditioning Macroeconomics From Keynes to Akerlof and Schiller G. AKERLOF-R. SHILLER, Animals Spirits. How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism, Princeton University Press (2009) Prof. Carles Manera, based on the reading of the book and the contributions of ESADEgeo-CENTER for Global Economy and Geopolitics, under the supervision of Profs. Javier Solana and Javier Santiso 1 THE “ANIMAL SPIRITS” IN JOHN MAYNARD KEYNES… • John M Keynes, General Theory of Employment, Interest and Money: “Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than on mathematical expectation, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits — of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities." Prof. Carles Manera 2 …affect all the economic agents • Keynes continues: “If the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die”. For Keynes, the only thing that motivates investors are conjectures drawn up on the basis of psychological states that have little to do with economic rationality. Keynes referred to these motivations using the term animal spirits, and believed that they were the reason for the volatility of investment, which in turn translated into fluctuations in production and employment, via the multiplier mechanism. However, this idea practically disappears during the reworking process of Keynseian theories that began almost immediately after the publication of the General Theory, and which led to the development of IS-LM analysis and the “great Neoclassical-Keynesian synthesis” of the ‘fifties and ‘sixties. (Source: http://www.librosdeeconomiayempresa.com/r014/articulo3.aspx; and John M Keynes, General Theory of Employment, Interest and Money). Prof. Carles Manera 3 Exception: Charles Kindleberger, Hyman Minsky • The essence of Kindleberger’s argument, based in turn on Hyman Minsky’s model, could be summed up as follows: the main cause (although not the only possible one) of economic cycles should be sought in certain psychological moments de – Keynes’ animal spirits – which generate unforeseeable fluctuations in the prices of assets. The beginning of the process may lie in some exogenous disturbance (a technical or financial innovation, for example, or a political change) which causes great expectations of profit in a sector. This optimism sets off an expansion wave which propagates easily thanks to the increase in bank credit (endogenous money supply). The expansion wave leads to what Adam Smith called overtrading, that is a situation of excessive “financial joy”: over-estimation of future yields from investments, reduction of the guarantees demanded by banks for granting loans and plain and simple speculation. In short, a financial bubble is created which ultimately ends up bursting. (Source: http://www.librosdeeconomiayempresa.com/r014/articulo3.aspx) Prof. Carles Manera 4 After Kindlerberger and Minsky… • On the crest of the expansion wave, certain individuals (generally those who have some kind of privileged information) withdraw from the market, but not without first selling their overvalued assets in order to make the corresponding gains. This creates problems for some financial institutions, which may go bankrupt, which ends up causing panic: investment contracts brusquely and the economy leaves the mania phase to enter the depression phase. The end of this situation comes when the prices of the assets have fallen enough and investors once again feel motivated to make long-term investments. (Source: http://www.librosdeeconomiayempresa.com/r014/articulo3.aspx; and Charles Kindlerberger: Manias, Panics and Crashes, Palgrave Macmillan, 2011; Hyman Minsky, Stabilizing an Unstable Economy, MacGraw-Hill, 2008). Prof. Carles Manera 5 BASIS OF THE MAINSTREAM ECONOMIC THEORY • That everybody who intervenes in the economy does so for economic reasons, and their behaviour is RATIONAL. • THIS IS WRONG. • Let us remember John Maynard Keynes: Animal Spirits govern many economic activities, with clear premises: the stimuli are not always economical, and the decisions made are not invariably rational. Prof. Carles Manera 6 HOW CAN WE UNDERSTAND ECONOMICS? • Bearing in mind how the economy is affected by these “animal spirits”: this is the only way we can comprehend the instabilities of capitalism. • The “animal spirits” cannot be reduced to mathematical formulae or econometric models: which is why economics has ignored them. • But Economic History shows that these “spirits” form part of reality and that if they are not taken into account, the interpretation of the economy with mainstream theories is insufficient in the end. Prof. Carles Manera 7 THE FIVE “ANIMAL SPIRITS” for Akerlof-Shiller • • • • • 1. Fairness. 2. Confidence. 3. Corruption, fraud and bad faith. 4. Money illusion. 5. Stories. Prof. Carles Manera 8 1. FAIRNESS • • • • • Wages: in the Neo-classical theory, a wage is just another price that adapts to a market deemed symmetrical and perfect. But one determining factor is the perception people have of fairness: the huge wage disparity (which increases in times of crisis) is seen by the population as an element of inequality. Of unfairness A correct socio-psychological theory of fairness can explain facts as important as unemployment. [The Akerlof-Shiller approach is reminiscent – although not necessarily exactly – of the contributions of economist Michael Kalecki and his theory of exploitation; and from another perspective, of the works of Daniel Kahneman, winner of the Nobel Prize in Economics in 2002. To discover Kalecki, see Manera (Capitalisme desfermat pp. 88-92). The main contribution made by Kahneman to economic science consists of the development of the prospect theory, according to which individuals make decisions in uncertain environments, which diverge from the principles of probability. This is what is known as “heuristic shortcuts”. One manifestation of heuristic shortcuts is loss aversion. In this way, an individual prefers not to lose 100 dollars rather than to gain 100 dollars, which makes for asymmetry in decisionmaking. The importance of Kahneman’s research lies in its utility for moulding non-rational behaviour, which diverges from the Neo-classical conception of the homo economicus and comes closer to the Keynesian theory and certain theories of the economic cycle. His latest book, “Thinking, fast and slow”, has been translated into Spanish: Pensar rápido, pensar despacio, Debate, Madrid 2012]. Prof. Carles Manera 9 2. CONFIDENCE • This is the most important of all the “animal spirits” for the economy. Confidence is irrational: it means that people act according to what they believe is right. • The current financial crisis is to a large extent a consequence of the low level of confidence. • Which is why the State must intervene to compensate for that deficit of confidence and return the credit necessary for recovering jobs. Prof. Carles Manera 10 3. CORRUPTION, FRAUD AND BAD FAITH • Some fluctuations can be attributed to the acceptance of shameless corruption. E.g.: Enron and the fraudulent abuse of accounting principles, relationship to the 2001 recession (see Joseph Stiglitz: “The Roaring Nineties: Seeds of Destruction” [Los felices 90. La semilla de la destrucción, Taurus, Madrid 2003]). Subprime mortgages are at the base of the recession that started in 2007 (see Carles Manera: Capitalisme desfermat, Lleonard Muntaner Editor, Palma 2012). Prof. Carles Manera 11 4. MONEY ILLUSION • Money illusion is when economic decisions are based on the nominal value of money. It is the impression individuals and companies have of having increased or decreased their purchasing power after a change takes place in their nominal incomes or prices. INFLATION IS NOT TAKEN INTO ACCOUNT, leading to loss of real purchasing power. • The presumption of mainstream macroeconomics is that the economic agents (in particular workers) are not affected by money illusion. Examples to the contrary: some contracts that do not index salaries to real inflation; or the fact that public debt bonds have an interest rate that does not vary as inflation evolves. Prof. Carles Manera 12 5. STORIES • Individual and collective stories: the human mind thinks in terms of narratives. • “Stories” move markets: they have a real economic effect. They are an important source of confidence, or lack thereof. They can infect or demotivate it. Prof. Carles Manera 13 OTHER KEY ELEMENTS: CENTRAL BANKS • 1. CENTRAL BANKS AND THEIR INFLUENCE ON THE ECONOMY A central bank can influence the amount of money in circulation by means of: a) Open market operations: they affect interest rates and total volume of credit. b) Direct loans to private banks, generating confidence. Akerlof-Shiller recommend stimulating b) in the current (although the results are not very solid in Europe). Prof. Carles Manera 14 OTHER KEY ELEMENTS : INFLATION AND UNEMPLOYMENT 2. INVERSE RELATIONSHIP BETWEEN INFLATION AND UNEMPLOYMENT • When there is full employment, workers ask for wage increases. • There is high inflation when unemployment is low (Phillips curve). • But economic policy may be more concerned with securing the lowest possible inflation, neglecting the level of unemployment, which will reach what the Neoclassical theorists call the “natural rate of unemployment”. Prof. Carles Manera 15 OTHER KEY ELEMENTS : THE CURRENT CRISIS • Another important aspect of Akerlof and Shiller’s book is the analysis of the current financial crisis, which is basically interpreted as a crisis of confidence: The collapse of confidence in certain financial products and a certain modus operandi of the banking institutions. Although, along with the confidence factor, the authors also highlight the importance of corporate corruption in the development of the crisis. They do not use the term “corporate corruption”, but they do highlight the role of corruption in the sense of “bad faith” – yet another manifestation of the animal spirits – , especially in relation to the practices of “creative accounting”, the processes of creation and diffusion of a series of financial products that are increasingly opaque and risky, the behaviour of the rating agencies, etc. With regard to the question of how to exit the crisis, the authors support the measures to rescue the financial institutions that were affected the most by it, and stress the need to regulate the financial system in such a way that similar situations can be prevented in the future. (Source: http://www.librosdeeconomiayempresa.com/r014/articulo3.aspx) Prof. Carles Manera 16