Animal Spirits

by Jerry O’Driscoll

In a previous post, Mario Rizzo reminds us that Keynes was concerned with the volatility of investment.  Keynes was not alone.  By the dawn of the 20th century, virtually every significant business cycle theorist viewed the volatility of investment as the central theoretical problem.

In the General Theory, Keynes (p. 149) posed the problem as follows: “The outstanding fact is the extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made.” It quickly becomes clear that Keynes means “expectations,” not knowledge.  And investment is not governed by “the genuine expectations of the professional entrepreneur” (p.151).

Long-term valuations become “a game of Snap, of Old Maid, of Musical Chairs” (pp. 155-56).  He then presents what has become known as the Keynesian beauty contest in which investors must guess what other investors will guess.   It is average opinion guessing what average opinion will guess about average opinion to “the fourth, fifth and higher degrees” (p. 156).   For Keynes, how do we break out of these straitjackets?  It is through bouts of “spontaneous optimism” or “animal spirits” (p.161).

Keynes was predisposed to offer psychological explanations for economic behavior.  In Two Philosophies of Money: The Conflict of Trust and Authority, S. Herbert Frankel took note of that propensity. “Keynes was fond of referring to psychological factors but as various writers have pointed out, in particular Professor Gunter Schmolders, his psychology was of the crudest.  It consisted largely in setting up abstract puppets or models of his own very unsophisticated beliefs concerning the motives which cause individuals to act in a certain manner” (p. 127,n27).

Keynes offered little more than pop psychology to buttress his policy prescriptions.  Yet current policy is predicated on animating animal spirits. Keynes had an explanation for how that could come to be: “Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back” (p. 383).

5 thoughts on “Animal Spirits

  1. What’s the best behavioural economics informed “animal spirits theory” out there? I’ve read the book by Akerlof and Schiller and, honestly, I couldn’t really find a “big shiny theory”, although the book – together with the “The Return of Depression Economics” – have gained a huge audience and are inspired imitations elsewhere.

  2. Bogdan:

    I’ve written a paper that may go some ways to addressing your question. The paper tells where I think macro is headed. I’ve posted it here:

    I think the “New Interventionist Economics” will be characterized by Bubbles, Radical Uncertainty, Animal Spirits, Complexity dynamics, and Extra-market control.

    I think the leading definition of “Animal Spirits” is “irrational or arbitrary waves of optimism and pessimism,” which is not Keynes’s definition. Whether you can have a “theory” of animal spirits so defined depends on whether it counts as “theory” when the variable in question moves in arbitrary and unpredictable ways.

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