Monday, 23 February 2009

Animal spirits

Here's a very simple argument from Akerlof and Shiller for why behavioural factors need to be taken into account in macroeconomics:

In their attempts to clean up macroeconomics and make it more scientific, the standard macroeconomists have imposed research structure and scientific disciple by focusing on how the economy would behave if people had only economic motives and iof they were also fully rational. Picture a square divided into four boxes, denoting motives that are economic or noneconomic and responses that are rational or irrational. The current model fill only the upper left-hand box; it answers the question: How does the economy behave if people have only economic motives, and if they respond to them rationally? But that leads immediately to three more questions, corresponding to the three blank boxes: How does the economy behave with noneconomic motives and rational responses? With economic motives and irrational responses? With noneconomic motives and irrational responses?

We believe that that the answers to the most important questions regarding how the macroeconomy behaves and what we ought to do when it misbehaves lie largely (though not exclusively) within those three blank boxes.

I'll post some bits and pieces from the book, which is pretty good if not quite as great as I was expecting, in the next few days.

And here's the passage from Keynes' General Theory that they take the title of their book from, which is rather good too:

Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits - of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole, is it based on the exact calculation of benefits to come. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but mathematical expectation, enterprise will fade and die; - though fears of loss may have a basis no more reasonable than hopes of profit had before.

Apologies for typos as usual...

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