Review of Animal Spirits by George Akerlof and Robert Shiller (Princeton University Press)

by Richard BRONK
Visiting Fellow, LSE

It is always exciting for an academic author when their new book seems to be part of a new tide in the intellectual history of their discipline. So, it was with delight, as author of The Romantic Economist, that I embarked on reading Akerlof and Shiller’s Animal Spirits – also just published. Here were heavyweight reinforcements for the long overdue assault on the myopia of the economics profession concerning the role of sentiments.

In most respects, I was not disappointed. For one thing, ‘Animal Spirits’ accords beautifully with one of the main recommendations of ‘The Romantic Economist’ (and Alfred Marshall, for that matter): it is written in what Wordsworth called a ‘language really used by men’, so that its arguments and assumptions are readily accessible to specialists and non-specialists alike.  For another, the book presents a rigorous case for the importance of ‘confidence multipliers’ and ‘stories’ (or narratives) in explaining recent market behaviour; and for the role of ‘fairness’ and ‘money illusion’ in preventing wages from falling in recessions to the market-clearing rate. Indeed, the book is a very useful practical primer for policy-makers and practitioners (as well as academics) on most aspects of the current crisis. Finally, Akerlof and Shiller make a compelling theoretical case for incorporating non-economic motives (and responses that do not accord with the axioms of rationality) into macro-economic theory.

There are many particular insights: for example, that the fateful switch in 2000-2007 from equities to investment in real estate (and credit) was partly caused by loss of faith in the accounting of the corporate sector following the Enron scandal; and that the 1930s depression was partly so protracted because companies feared to invest as a result of uncertainty about the political reactions of governments to public disgust with capitalism.

There are also a few lacunae in the argument. In particular, the authors are unfair to Adam Smith’s model – though in a very interesting way: they ignore the key role in society that Smith assumed for moral sentiments, as well as his emphasis in ‘The Wealth of Nations’ on sentiments such as fear and unease. Smith was much more concerned about the dangers of the visible hand of government causing debilitating fear and unease among entrepreneurs than he was eloquent about the optimality of the invisible hand of the free-market; and this lesson needs to be remembered. For Akerlof and Shiller, the destabilising nature of ‘animal spirits’ justifies government intervention and this must be correct up to a point; but, as Smith reminds us, if this intervention is seen as arbitrary and unpredictable, it may be self-defeating and undermine the confidence of savers and investors alike. Furthermore, Smith’s explicit and implicit assumption that powerful moral sentiments underpin market interaction is also important. As the Romantic philosopher and poet Coleridge argued, economic rationality is the fragile product of a necessary balance between the ‘lust of lucre’ and moral restraint. As many have argued since (from Ruskin to Fukuyama), moral sentiments (like loyalty and trust) are positive stabilising forces that boost confidence and efficiency – particularly in conditions of uncertainty. These good sentiments perhaps receive insufficient attention in ‘Animal Spirits’.

I have a couple of other quibbles with this excellent book. First, it seems odd to lump together confidence effects, a sense of fairness, corruption and anti-social behaviour, money illusion and cultural stories under the catch-all rubric of ‘animal spirits’. Some are basic emotions, some moral (or immoral) sentiments, and others social or cultural frames of reference. This is not merely a semantic point: the differences between these disparate exceptions to economic rationality suggest differences in where we should look for answers – psychology, applied ethics and sociology. It is true, though, that there is something (not acknowledged by the authors) that unifies most of the spirits discussed: they were identified in general terms by the Romantic critique of rationalism. I would argue that this critique provides the lost conceptual context for most of Akerlof and Shiller’s points and one that could help further develop and refine them. In particular, it would suggest quickly the ghost at the banquet – the role played by the imagination. For imagination not only plays a role in many of the framing issues discussed (for example, the young can hardly imagine themselves being old, let alone the interests they will then have); imagination and creativity also play a key role in causing uncertainty in markets. Many of the inflection points in markets are when key players imagine new options, create new goods or create new dominant images of the future.

Finally, Akerlof and Shiller make a ringing call for macro-economic theory to take animal spirits seriously – and so it should. But there are two ways of doing this: one is to co-opt into standard models the findings of psychology and sociology where they suggest systematic regularities (the option favoured by the authors); the other is to make clearer the boundaries of applicability of standard models and the need to supplement them with models from other disciplines when dealing with many facets of the economy. Which route economics takes matters. It is possible that disciplined cooperation between pure paradigms from different disciplines might be more fruitful in the end than continual reengineering of the standard paradigm in economics. The ‘cooperation between disciplines’ option would, though, require economics to give up its imperial pretensions to explain everything in the socio-economic sphere on its own.