Peter Dougherty
on Animal Spirits

February 19th, 2009 by EVENTS

Several years ago when I began to work with George Akerlof and Robert Shiller on their book, Animal Spirits, Bob Shiller made the offhand comment that macroeconomics—our understanding of the economy as a whole—is the part of economics most susceptible to psychological influences. This comment struck me at the time as unusual because I, like most observers, tend to think of behavioral economics as applying most powerfully to microeconomic phenomena—things like cognitive bias and the role of emotions in economic decision making. But when I reflected on Shiller’s comment and began thinking of the bubbles in asset and housing markets as examples of what he was talking about, his point hit home and I began to grasp what he and Akerlof meant by behavioral macroeconomics. It was then that the idea behind Animal Spirits came into focus for me.

Now, as we publish this book into the jaws of a severe recession fueled by a subprime mortgage bubble driven in large part by people’s belief that the value of their homes could only increase, the psychological dimension in the economy has emerged into full view. This timing provides a prime teaching moment for Akerlof and Shiller regarding the behavioral nature of macroeconomic activity, and a fitting opportunity for two distinguished economists to engage their colleagues in an enriched discussion of the relevance of economic theory to public policy. Further, the authors bring their thinking to bear on the issue on the minds of many of their other readers: how did we get into the current recession? what must we do to get out of it?

Still, there remains in this book a larger payoff for the greater intellectual conversation and that, I think, is its enduring relevance.

To my mind, it is in its investigation into the nature of capitalism that Animal Spirits displays its most profound and enduring insight. Early on, Akerlof and Shiller note that market capitalism, for all its dynamism, left to its own devices, produces disruptive outcomes, including bubbles, manias, and crashes, and their wrenching aftermaths—hence the need for the guiding hand of government. While there is nothing new in justifying a role for government in the economy, what struck me as particularly compelling in this case is the authors’ observation that the instability inherent in market capitalism is behavioral in character—that is, driven by all-too-human psychological and sociological forces, or “animal spirits.” Thus, any understanding of how a capitalist society manages its economy necessarily requires an appreciation of its behavioral dimension—its culture. Economists seldom talk about culture, but that is exactly where Akerlof and Shiller’s analysis leads.

While Akerlof and Shiller are compelling in their observations about the cultural and psychological dimension of capitalism, they do not claim originality for their insight. Rather they trace it back to John Maynard Keynes, who used the term “animal spirits” during the Great Depression and reserved an important role for non-economic, psychological forces in his explanation of how economies work. Culture, in the guise of psychology, mattered to Keynes.

In some thirty years working with social scientists on their books, one of my greatest editorial challenges has been in trying to reckon the seemingly contradictory ideas of economists with those of cultural scholars—sociologists, historians, and political theorists—about how the world works. Economists emphasize rationality, incentives, and prices; their more culturally minded colleagues across campus emphasize mores, norms, and institutions. My own frustration with this conundrum led me to appreciate how Adam Smith managed to combine these two impulses in his work. To paraphrase intellectual historian Jerry Z. Muller, author of Adam Smith in His Time and Ours, Smith saw the good society as one that combined the growth-producing power of the market and other economic institutions with the countervailing civilizing influence of education, religion, the family, law, and government—cultural institutions—in a creative equilibrium.

But whereas Smith and his classical successors described an economy lacking the convulsions of boom and bust, Keynes—and now Akerlof and Shiller—have had to describe economies characterized by large doses of unemployment. And although Keynes, Akerlof, and Shiller, each an economist to the marrow of his bones, explains unemployment in rationalist economic terms, all reserve an important place for culture—“animal spirits”—in coming to grips with the way the world works. Without accounting for animal spirits—features such as confidence and fear, a concern for fairness, greed and bad faith, and the modern folk stories of economic success and failure—it is impossible to explain protean forces such as bubbles and busts, or so Akerlof and Shiller argue. At the same time, in recognizing these powerful behavioral impulses, Akerlof and Shiller affirm anew a necessary role for the countervailing institution of government in checking and guiding the market.

The lesson for economists and policymakers in Animal Spirits is that for all the power formal models and econometric precision bring to bear in explaining the economy, it is vital to step back and recognize that we are not describing machines, but rather humans, and that humans inevitably bring a fuzziness to the table. If the economy is really to be properly understood, the presence of animal spirits necessitates a larger, more behavioral view. Seen in this light, it is no accident that Bob Shiller, ever alert to animal spirits, foresaw both the 2000 stock market crash and the 2008 housing market crash.

Meanwhile, the lesson for publishers is that in developing our lists we must remain open to the full range of explanations, and that occasionally, if we are attentive, we will be lucky enough to find and publish books like Animal Spirits that combine the best features of economic as well as cultural thinking, and advance the intellectual legacy that dates back to Keynes and even Adam Smith himself.

Peter J. Dougherty is Director of Princeton University Press.

Robert Shiller is the Arthur M. Okun Professor of Economics at Yale University and also the author of the recent book, Subprime Solution: How Today’s Global Financial Crisis Happened and What to Do about It. George Akerlof is the Koshland Professor of Economics at the University of California, Berkeley. In 2001, he won the Nobel Prize in Economics.

Posted in Editors Speak


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