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William Goss

Pol 429
September 25, 2015
Book Review
Animal Spirits: How Human Psychology Drives the Economy, and Why It
Matters for Global Capitalism
The book I chose is Animal Spirits: How Human Psychology Drives the
Economy, and Why It Matters for Global Capitalism written by George Akerlof
and Robert Schiller. The two of them use this book to answer the question of
how and why animal spirits and human psychology have an effect on
global economies and capitalism. The five animal spirits are confidence,
fairness, corruption, money illusion, and stories. They use previous economic
theories and literature, mostly the theories of Adam Smith and current
economic textbooks to prove why animal spirits further part of their theories,
but mostly to show why animal spirits are why they are wrong and why they
are right. The current theories, they say, strictly seek to minimize as much as
possible departures from the pure economic motivation and rationality, but
does not include psychology or philosophy. The topic discussed throughout
the book is very important to investigate because the U.S. economy, and
especially the global economy has tons of money at stake, and there are
stark similarities between both of the depressions discussed and the great
recession to why their theory is right. If they can show that their theory is
right, and how to handle these situations and emotions more effectively, we
might be able to prevent or dampen future depressions and recessions; and
this obviously saves everyone a lot of money and stress.
The authors use data from a wide variety of historical economic data
and numbers. They use historical data like inflation and deflation rates,
interest rates, money supply, major stock market indexes, and archives of
newspaper articles and stories from certain time periods to show what was
happening economically during that period and why it was happening. They
try to correlate this data and information to animal spirits and compare it to
different time periods to show similarity and consistency in the fact that
animal spirits are why those numbers and data were what they were.
The research strategy is to go through first a series of three major
questions regarding economics and relate them to historical times and
findings. They then explain why animal spirits is the reason why the historical
situations, and the 2008 credit crisis, happened. They then go through a
series of five more questions to reinforce their major theories, and these are
quicker and designed to reinforce their point. Most of the analyses and
findings make sense; however, we should keep in mind while reading their
analyses that theyre answering these questions based off of their theories
and time periods. Most of the historical situations that they discuss, in my
mind, are easy ones to explain with their theories. I am not saying they are

wrong in any way, but there are many other historical happenings and
variables when it comes to explaining why economic situations happen.
Throughout the book, they are basically trying to prove one argument,
which is: That there is more to global capitalisms most commonly viewed
way of moving, which originates by Adam Smith. Smith states that capitalism
will always be successful because is people rationally pursue their own
economic interests in such free markets, theyll exhaust al mutually
beneficial opportunities to produce goods and will exchange with one
another. Such exhaustion results in full employment, resulting in a successful
economy. The authors claim, however, that while Smith was basically right
with unemployment, this theory fails to describe why there is so much
variation and volatility in the economy, and it fails to include peoples
noneconomic motivations, irrational motivations, and misguided motivations,
which they call together animal spirits. There are three major questions,
and five minor questions, they use as examples in order to have different
hypotheses about the five animal spirits driving global capitalism.
The first question they investigate is why do economies fall into
depression? Their hypotheses are that animal spirits play a large role in the
depression of the 1890s and the Great Depression of the 1930s. They claim
that because animal spirits played such a large role in the depressions, which
is the worst economic situation to happen, that animal spirits can essentially
play a role in any economic situation.
They begin this investigation by first quickly running through how
depressions come about and why the two are very similar according to their
findings. They start off by showing the economic conditions throughout the
life of both of the depressions, which are very similar and are as follows. Both
start off with a very confident and overheated economy, one which people
just over spend, and invest in anything even with out any rationality. Then,
when everyone is just coasting along all happy, a trigger event happens,
like the Silver Purchase Act of 1890, which was a plan for legal paper tender
to be backed by silver or gold. They explain how once an event like this
occurs, this brings along panic with people and people become very
unconfident with the banks and liquidate and try to withdrawal their money
from the banks. This brings along a rise in unemployment, and a dip in
spending and investing. Then we see that makes the economy a terrible one,
and a public that is at a standstill with no confidence, which drags on for far
too long.
After explaining what made the two depressions happen, they review
what happen and explain why they happened and how animal spirits play a
role in what happened. First they use overconfidence to begin. This is shown
with exuberant spending and crazy amounts of lending and investing, even
with no rationality as to why they want to make those investments. At this
point, the public had forgotten about past instances in their lifetime or
familys lifetime where the economy wasnt healthy, which they cite the next
animal spirit, stories. The good economy had been going on long enough
that the history of bad time periods or situations had slipped their mind,

which makes them act as if theyre invincible. Then comes the trigger, which
they cite as the Silver Act. Once the trigger occurs, confidence plummets and
their memories and stories of banks failing and people withdrawing their
money come back into their minds. This makes people very unconfident in
the situation and people flee to the banks to withdraw their money; however,
the banks only keep roughly 6% of their debits in cash, creating a huge
mess. Subsequently, the economies see a huge dip in the markets, which
creates deflation and less production. Companies are then put into the
situation where they need to make cuts somehow, and they say this is where
fairness comes in. For example, from 1929 to 1931 the Consumer Price Index
had lost 12.7% while the wages only fell 2%. This forced companies to fire a
lot of people during that time period driving the unemployment rate up to a
record 26.6% in 1931, and it would not fall below 10% until 1937. They say
this was due to fairness and money illusion. People thought that it was unfair
that they were going to make less money while doing the same job. This was
irrational and led to unemployment being worse and worsening the economic
problems. This was irrational because they did not realize the difference
between nominal and real wage cuts. If they would have realized their wage
cuts still would have been better than before, due to the crash of the CPI,
and not just cared about the high nominal value, the unemployment
situation would have looked a lot better; which ultimately, would have kept
the depression at a certain degree of severity and made it not drag on so
In addition to confidence, fairness, and money illusion, they also cite
corruption. According to a Chicago Tribune article from 1930, corruption was
at an all time high and the worsening economy was enticing a record amount
of corruption. This included high amounts of counterfeit money and reporting
false information to investors, so people would invest their money in the only
investment that seemed like it was a good investment. This furthered the
problem even further because once it got out people did not know what was
true or not, and there was fake money out in the money supply. To sum up
the first question, they find that animal spirits had a lot to do in creating the
two depressions, and definitely prolonging them.
The second question is why do central bankers have power over the
economy (Insofar as they do)? They use this example to show that the
creation of central banks was to ensure one major part of the animal spirits
would not crash as hard as the past, which was confidence. They first
describe what a central bank does, using the U.S. Fed as their example.
According to the authors, they do two things. First, open market operations,
buying and selling bonds to effect the money supply. Secondly, rediscounting where they change interest rates to have an effect on inflation.
They tell the story of how Nelson Aldrich, Rockefeller Jr., and four leading Wall
St. bankers met for a week and pretty much created the fed, due to too
many bank runs to panic and crashing of confidence. The authors then
relate how the Fed works to the 2008 recession, and they do this with a story.
The story was how the Fed lent J.P. Morgan roughly thirty billion dollars in

order to buy Bear Stearns for $2 per share, a huge discounted price to precrash prices, in order to avert another Lehman Brothers type crisis. This was
an absolute last resort to avert crisis; however, the Fed believed it was worth
it to keep confidence from crashing further and keeping the situation from
getting worse. This shows how such a big aspect of our economy and a
particular decision of that part of the economy was due to keeping
confidence of our people from crashing to avert further crisis.
The third major question they investigate is why are their people who
cant find a job? They focus on the fairness animal spirit in describing why
this is. They start the investigation by running through why, according to the
widely held economics theories, everyone should have a job. Just like stock
and commodity prices, if something is too high, just bid lower. The theory
says the same is with jobs, if something is too high, just bid, or accept a
lower job. However, they say that in the U.S., that people get stubborn and
do not accept a job that has an unfair pay for their skills., and that some
people would rather stay unemployed for longer, rather than accept a lower
job. They also say the the wage efficiency theory has a part of why people
cant find a job. This is because if a company lowers pay to an incoming
employee, if they find one to accept lower pay, then the company also needs
to lower the pay of the existing employees to keep an equal rate of pay for
skills and tenure. However, when this happens, existing employees get mad
and motivation and production is lost, so this causes companies to just not
hire and have their existing higher earning employees stay and responsible
for more work rather than hiring new ones and risk unrest. They say that
those two reasons are directly related to fairness and that the U.S.
population is too obsessed with fairness, and it creates an environment
where either people wont accept jobs and especially an environment where
companies cant afford to hire new employees, both having a huge effect to
why there are cycles in the unemployment rates.
The last five questions which are why is there a trade-off between
inflation and unemployment in the long run, why is saving for the future so
arbitrary, why are financial prices and corporate investments so volatile, why
do real estate markets go through cycles, and why is there special poverty
among minorities, are designed to reiterate what the authors have discussed
and mostly show examples of confidence and fairness to reaffirm the point
that animal spirits have an effect on different aspects of the economy. These
questions and example sum up the hypotheses of the authors by showing
more examples of why animal spirits have an effect on the decisions that
people make, which causes cycles in the economy, and creates dips,
recessions, and depressions rather than a consistent and always growing
economy. They once again use the examples of confidence and fairness the
majority of the time to show why these last give questions occur, and
showing why everything investigated goes into certain cycles due to those
two spirits.
This sums up the research investigated according to their theories.
Throughout the eight questions they went through eight different scenarios

showing how the five animal spirits were largely the cause of the different
scenarios, especially depressions, the acts of central banks, and the job
market. I believe that their theories are born out and they reject the null
hypotheses. They clearly show that animal spirits and psychology do have an
effect on the economy and global capitalism, and that the economy doesnt
just consistently grow like previous theories. They do a good job of showing
why animal spirits have an effect on certain scenarios and that is why they
happen, and it really does do a good job convincing people that it is the
reason for the movement. These findings are very important because of the
implications of them, when they go through data and investigations
regarding two major depressions, the credit crisis of 2008, unemployment,
real estate, and major economic questions, they are dealing with major
things. Things that the world evolves around, so they are very important
questions to know and situations to know how to handle yourself and your
money. In order to come full circle with their findings, they should do an even
more up to date preface, with the current one being from 2009. They need
this because for the most part the economy has pulled its way out of the
recession from 2008, and is now currently moving in the right direction. They
need a preface with research on what happened in order to get out of the
recession, and what is currently being done to continue it, and what
implications we have seen. We need this because this will prove even further
what animal spirits did to get us out of the recession and teach us even more
on what we need to do to prevent it from happening in the future and what
we need to do to prevent situations from getting worse.
Although they do a good job of convincing people that animal spirits
are in fact a part of the economy, which I believe as well, and using the right
questions, which I believe because of the implications of each one, they do a
poor job at showing that animal spirits are just part of the equation. The
authors only talk about the certain questions and scenarios in terms of why
the animal spirits cause the movements to happen. However, they rarely, if
ever, talk about other variables or parts of the equation that makes things
move or happen. I think this hurts their credibility because they seem
ignorant when they believe that only animal spirits make certain things
happen or move.
I have a couple of main examples of why this occurs and where in the
book they dont consider all of the equations. The first example comes from
the chapter about why people cant always find a job. I personally think they
are just partially right in this chapter. They are correct when they show that
people dont like unfairness and that some wont accept a wage cut to match
deflation. However, they only explain why fairness makes this happen, and
fail to go into detail to the implications, which I think are two big problems.
First, that when people dont accept wage cuts while deflation is happening,
the economy goes into a faster spiral because why would consumers
purchase an item when they it is going to be cheaper tomorrow and the next
day? Then, you have companies making less in sales and still paying their
employees the same amount of money or firing people, which just creates

more unemployment. Second, I dont think that the U.S. need fairness makes
companies not hire in every situation. I believe that sometimes it just makes
them hire elsewhere where they can get people to accept lower wages. This
is when they go to China or other countries, mostly in Asia, where there are a
lot of people that will accept lower pay. I am not saying that this is right or
that companies should do this, but when you can get cheaper labor and
goods, especially in poor economic conditions, a lot of companies will go that
route instead of hiring in the country, which furthers the economy even
The next two examples I am going to use relate back to class as well.
In the book, they use the examples of why minorities are more susceptible to
poverty and why people dont save their money. They say that people have
stereotypes about minorities which leads to negative psychology with them,
leading to no confidence and the lack of hiring, especially high paying jobs.
With the saving question, the authors say that people historically dont like to
save and would rather spend their money on goods, or invest their money in
the wrong things. This also has to do with confidence and having too much of
it. Although, some of their theories are correct, I think that there are bigger
problems that have to do with these two examples, and for the most part a
lot of the book. This problem is the problem of education, and the cost of
education yourself about certain aspects of life. Just like with politics, the
majority of the population doesnt know about how to invest, how to save
correctly, let alone get a higher education in order for companies to have the
confidence to hire you and for you to have enough money to educate
yourself further and to save and invest.
They do not discuss any other variables to these problems other than
just animal spirits and I believe that they miss huge problems like these. I
think these are huge problems because if the majority of the population had
general knowledge of things like investing, saving, how the economy works,
who the Fed is and what they do, what economic terms are, the world would
be much better off. If the population had that education, I think that people
would know how to behave themselves in good economies, prepare for bad
situations and the future, react to triggers, and pull themselves out of bad
I believe they do a good job at showing why animal spirits have a big
role in economic situations and scenarios, and agree with them that they do,
and we can learn a lot from them; however, I believe that this book would be
much more complete if they included more variables like outsourcing and
deeper problems like education of the public. I believe if this was the case,
on top of the findings and recommendations of animal spirits, the U.S. could
learn a lot about how to prevent negative cycles in the economy, react to
dips better, and pull themselves out of negative time periods better and
quicker. With this being said, I would highly recommend the book. I say this
because although they could include a lot more, and should, they still do an
outstanding job at showing why animal spirits of our population has huge
implications on economics. These findings can teach people how to act,

prepare, and react to certain economic situations, and these teachings

ultimately can save people and countries billions, if not trillions, of dollars,
stress, and time. If they can change the ways they do things in regards to
emotions and animal spirits, people will be much better off and confident
that they will become economically sound, and stay that way through any
economic cycle.