Animal Spirits, An Obama Book Club Selection

White House Budget Director Peter Orszag... has been spending his time recently reading not about spreadsheets, but about psychology. In particular, he has been reading a new book by the economists George Akerlof and Robert Shiller called "Animal Spirits: How Human Psychology Drives The Economy, and Why It Matters For Global Capitalism."  ("A White House Seized by the Animal Spirits," TIME.)

A book by two economics professors has the attention of the White House. It implies we're irrational economic animals and the government is the wise zookeeper.

First, here's a definition of "animal spirits" as coined by British economist John Maynard Keynes (1883-1946).

"The colourful name that Keynes gave to one of the essential ingredients of economic prosperity: confidence. According to Keynes, animal spirits are a particular sort of confidence, ‘naive optimism.' He meant this in the sense that, for entrepreneurs in particular, ‘the thought of ultimate loss which often overtakes pioneers, as experience undoubtedly tells us and them, is put aside as a healthy man puts aside the expectation of death.'"

According to Akerlof and Shiller, Keynes focused on animal spirits as "referring to a restless and inconsistent element in the economy." Today, it encompasses unrealistic negativism concerning the economy as well as naïve optimism.

Here are several key points from the professors' book, a current favorite of the White House Book Club.

(1)  The authors accept Keynes' understanding of the role of government vis-à-vis citizens with regard to the economy. For them, it's like a parent-child relationship.

"The proper role of the parent is to set the limits so that the child does not overindulge her animal spirits. But those limits should also allow the child the independence to learn and to be creative. The role of the parent is to create a happy home, which gives the child freedom but also protects him from his animal spirits." (p. ix) (Italics in the original.)

Government - parental provider of the happy home.

(2) The current downturn in the U.S. economy can be traced to inadequate parental oversight.

"The permissive-parent view of the role of government replaced the Keynesian happy home. Now, three decades after the elections of Margaret Thatcher and Ronald Reagan, we see the troubles it can spawn. No limits were set to the excesses of Wall Street. It got wildly drunk. And now the world must face the consequences." (p. xi) 

So we make economic decisions based, in part, on our adolescent "feelings." (This is behavioral economics. It assumes we're human. Ground-breaking stuff.)  Consequently, our animal spirits can, particularly in the midst of an economic crisis, override our rational decision-making abilities. 

(3) When animal spirits are free to roam amidst an undisciplined, under-regulated free market bad things can, and often do, happen, say the authors.

"[T]he bounty of capitalism has at least one downside. It does not automatically produce what people really need; it produces what they think they need, and are willing to pay for. If they are willing to pay for real medicine, it will produce real medicine. But if they are also willing to pay for snake oil, it will produce snake oil." (p. 26) (Italics in the original.)

If you were wondering why this book might be popular inside the Obama administration, the last quote might be a clue. It begs the question: So who is best equipped to decide what consumers really need over against what they just think they need? Here's an answer prompt: People think they need SUVs. So who's getting into position to decide that what we really need are small, fuel-efficient vehicles?  

In their brief discussion of the subprime mortgage implosion that was a catalyst to the 2008 recession, the authors never mention 1977 legislation requiring loans to unqualified buyers. They place total blame on predatory lenders.

"Many subprime lenders unfortunately issued mortgages that were unsuitable for their borrowers...The lenders were successful in placing these loans among some of the most vulnerable, least educated and least informed members of society. While such behavior may not have been illegal, we think the more egregious instances definitely deserve to be called corrupt." (p. 36) 

So, governmental complicity in the subprime mortgage meltdown was all the fault of under-regulation, but not over-legislation.

(4) Akerlof and Shiller eventually write what may bring some discomfort to White House readers: Government's counterproductive behavior can summon the baaaad animal spirits.

"Economic historical Robert Higgs concludes that in the United States, ‘Taken together, the many menacing New Deal measures, especially those from 1935 onward, gave businesspeople and investors good reason to fear that the market economy might not survive in anything like its traditional form and that even more drastic developments, perhaps even some kind of collectivist dictatorship, could not be ruled out entirely.' Such worries drove business investment to very low levels and brought corporate plans for expansion to a standstill." (p.70)

This should be a warning to the Obama administration: Government behaviors spooked the business community and investors when both were needed most to help lift the nation out of the Great Depression.  It may be happening again. Right now.

(5)  The impact of animal spirits during a financial crisis gives the government an "opportunity" to intervene. The economic professors offer this recommendation.

"[I]n our view capitalism does not just sell people what they really want is also sells them what they think they want. Especially in financial markets, this leads to excesses, and to bankruptcies that cause failure in the economy more generally...Such a world of animal spirits give the government an opportunity to step in. Its role is to set the conditions in which our animal spirits can be harnessed creatively to serve the greater good. Government must set the rules of the game...Indeed if we thought that people were totally rational, and that they acted almost entirely out of economic motives, we too would believe that government should play little role in the regulation of financial markets, and perhaps even in determining the level of aggregate demand." (p. 173)  

Harnessing our animal spirits to serve the greater good. (Don't we harness horses?)

Now we understand why this book is promoted as favored within the Obama administration. The White House is contemplating how our animal spirits can be managed so that we don't get hung-up on bailouts, government ownership of car companies and banks, and a mind-boggling $1.8 trillion dollar budget deficit in 2009. (Are enterprises in the medical marketplace next? Oh, wait, that's my animal spirits stirring.)

We're all just bundles of irrational animal spirits during critical economic times. We only know what we think we need, not what we really need. What we really need is best left for the federal zookeepers, like Peter Orszag, to determine. And then throw through the bars of our cages for our edification. Into our happy homes.

I wonder if my small dog knows how much he and I are economically alike.

The economist Friedrich August Hayek (1899-1992) once offered an alternative understanding of economic freedom than that inherent in Animal Spirits.

"The economic freedom which is the prerequisite of any other freedom cannot be the freedom from economic care, which the socialists promise us and which can be obtained only by relieving the individual at the same time of the necessity and of the power of choice; it must be the freedom of our economic activity which, with the right of choice, inevitably also carries the risk and the responsibility of that right." The Road To Serfdom

White House Budget Director Peter Orszag... has been spending his time recently reading not about spreadsheets, but about psychology. In particular, he has been reading a new book by the economists George Akerlof and Robert Shiller called "Animal Spirits: How Human Psychology Drives The Economy, and Why It Matters For Global Capitalism."  ("A White House Seized by the Animal Spirits," TIME.)

A book by two economics professors has the attention of the White House. It implies we're irrational economic animals and the government is the wise zookeeper.

First, here's a definition of "animal spirits" as coined by British economist John Maynard Keynes (1883-1946).

"The colourful name that Keynes gave to one of the essential ingredients of economic prosperity: confidence. According to Keynes, animal spirits are a particular sort of confidence, ‘naive optimism.' He meant this in the sense that, for entrepreneurs in particular, ‘the thought of ultimate loss which often overtakes pioneers, as experience undoubtedly tells us and them, is put aside as a healthy man puts aside the expectation of death.'"

According to Akerlof and Shiller, Keynes focused on animal spirits as "referring to a restless and inconsistent element in the economy." Today, it encompasses unrealistic negativism concerning the economy as well as naïve optimism.

Here are several key points from the professors' book, a current favorite of the White House Book Club.

(1)  The authors accept Keynes' understanding of the role of government vis-à-vis citizens with regard to the economy. For them, it's like a parent-child relationship.

"The proper role of the parent is to set the limits so that the child does not overindulge her animal spirits. But those limits should also allow the child the independence to learn and to be creative. The role of the parent is to create a happy home, which gives the child freedom but also protects him from his animal spirits." (p. ix) (Italics in the original.)

Government - parental provider of the happy home.

(2) The current downturn in the U.S. economy can be traced to inadequate parental oversight.

"The permissive-parent view of the role of government replaced the Keynesian happy home. Now, three decades after the elections of Margaret Thatcher and Ronald Reagan, we see the troubles it can spawn. No limits were set to the excesses of Wall Street. It got wildly drunk. And now the world must face the consequences." (p. xi) 

So we make economic decisions based, in part, on our adolescent "feelings." (This is behavioral economics. It assumes we're human. Ground-breaking stuff.)  Consequently, our animal spirits can, particularly in the midst of an economic crisis, override our rational decision-making abilities. 

(3) When animal spirits are free to roam amidst an undisciplined, under-regulated free market bad things can, and often do, happen, say the authors.

"[T]he bounty of capitalism has at least one downside. It does not automatically produce what people really need; it produces what they think they need, and are willing to pay for. If they are willing to pay for real medicine, it will produce real medicine. But if they are also willing to pay for snake oil, it will produce snake oil." (p. 26) (Italics in the original.)

If you were wondering why this book might be popular inside the Obama administration, the last quote might be a clue. It begs the question: So who is best equipped to decide what consumers really need over against what they just think they need? Here's an answer prompt: People think they need SUVs. So who's getting into position to decide that what we really need are small, fuel-efficient vehicles?  

In their brief discussion of the subprime mortgage implosion that was a catalyst to the 2008 recession, the authors never mention 1977 legislation requiring loans to unqualified buyers. They place total blame on predatory lenders.

"Many subprime lenders unfortunately issued mortgages that were unsuitable for their borrowers...The lenders were successful in placing these loans among some of the most vulnerable, least educated and least informed members of society. While such behavior may not have been illegal, we think the more egregious instances definitely deserve to be called corrupt." (p. 36) 

So, governmental complicity in the subprime mortgage meltdown was all the fault of under-regulation, but not over-legislation.

(4) Akerlof and Shiller eventually write what may bring some discomfort to White House readers: Government's counterproductive behavior can summon the baaaad animal spirits.

"Economic historical Robert Higgs concludes that in the United States, ‘Taken together, the many menacing New Deal measures, especially those from 1935 onward, gave businesspeople and investors good reason to fear that the market economy might not survive in anything like its traditional form and that even more drastic developments, perhaps even some kind of collectivist dictatorship, could not be ruled out entirely.' Such worries drove business investment to very low levels and brought corporate plans for expansion to a standstill." (p.70)

This should be a warning to the Obama administration: Government behaviors spooked the business community and investors when both were needed most to help lift the nation out of the Great Depression.  It may be happening again. Right now.

(5)  The impact of animal spirits during a financial crisis gives the government an "opportunity" to intervene. The economic professors offer this recommendation.

"[I]n our view capitalism does not just sell people what they really want is also sells them what they think they want. Especially in financial markets, this leads to excesses, and to bankruptcies that cause failure in the economy more generally...Such a world of animal spirits give the government an opportunity to step in. Its role is to set the conditions in which our animal spirits can be harnessed creatively to serve the greater good. Government must set the rules of the game...Indeed if we thought that people were totally rational, and that they acted almost entirely out of economic motives, we too would believe that government should play little role in the regulation of financial markets, and perhaps even in determining the level of aggregate demand." (p. 173)  

Harnessing our animal spirits to serve the greater good. (Don't we harness horses?)

Now we understand why this book is promoted as favored within the Obama administration. The White House is contemplating how our animal spirits can be managed so that we don't get hung-up on bailouts, government ownership of car companies and banks, and a mind-boggling $1.8 trillion dollar budget deficit in 2009. (Are enterprises in the medical marketplace next? Oh, wait, that's my animal spirits stirring.)

We're all just bundles of irrational animal spirits during critical economic times. We only know what we think we need, not what we really need. What we really need is best left for the federal zookeepers, like Peter Orszag, to determine. And then throw through the bars of our cages for our edification. Into our happy homes.

I wonder if my small dog knows how much he and I are economically alike.

The economist Friedrich August Hayek (1899-1992) once offered an alternative understanding of economic freedom than that inherent in Animal Spirits.

"The economic freedom which is the prerequisite of any other freedom cannot be the freedom from economic care, which the socialists promise us and which can be obtained only by relieving the individual at the same time of the necessity and of the power of choice; it must be the freedom of our economic activity which, with the right of choice, inevitably also carries the risk and the responsibility of that right." The Road To Serfdom