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Animal Spirits

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IN THIS SUMMARY …

IN THIS SUMMARY
Animal Spirits dissects standard economic theories and demonstrates their failure to account for human emotion, even though emotions have a large impact on the economy. George A. Akerlof and Robert J. Shiller state that there are five key “animal spirits” which influence global economics: confidence, fairness, corruption, money illusion, and storytelling. They begin by explaining each animal spirit in detail, and continue on to apply these animal spirits to historic economic examples and traditional economic theories. Economic depressions, the current financial crisis, unemployment, and inflation are a few of the economic aspects examined within.

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  • 1.  
  • 2. ANIMAL SPIRITS How Human Psychology Drives The Economy, and Why It Matters for Global Capitalism AUTHORS: George A. Akerlof and Robert J. Shiller PUBLISHER: Princeton University Press DATE OF PUBLICATION: 2009 230 pages
  • 3. FEATURES OF THE BOOK Animal Spirits would be of most benefit to individuals working within the field of economics.
  • 4. THE BIG IDEA In Animal Spirits , George A. Akerlof and Robert J. Shiller discuss the impact emotions have on economic policy and decision making.
  • 5. INTRODUCTION Animal Spirits dissects standard economic theories and demonstrates their failure to account for human emotions, even though emotions have a large impact on the economy. George A. Akerlof and Robert J. Shiller state that there are five key “animal spirits” which influence global economics: confidence, fairness, corruption, money illusion, and storytelling. They begin by explaining each animal spirit in detail, and continue on to apply these animal spirits to historic economic examples and traditional economic theories. Economic depressions, the current financial crisis, unemployment, and inflation are a few of the economic aspects examined within Animal Spirits .
  • 6. ANIMAL SPIRITS AND THEIR EFFECTS Traditional economic theory operates under the assumption that individuals act rationally and make economic decisions based on purely economic reasons. These economic theories are widely accepted by professional economists and are utilized in governmental policy-making. Unfortunately, traditional economic theory does not examine how the economy behaves when individuals make rational decisions based on non-economic reasons, irrational decisions based on non-economic reasons, or irrational decisions based on economic reasons. In the quest to make economics a more scientific and calculable study, economists have largely left out the single largest influence on the economy: the animal spirits of human emotion.
  • 7. ANIMAL SPIRITS AND THEIR EFFECTS All animal spirits fall into one of five different categories: confidence, fairness, corruption, money illusion, and storytelling . All of these categories have strong effects on the current economy, and their influence must be taken into account when creating government policy and making economic predictions. Ignoring the fact that human emotions affect purchasing and financial decisions only serves to create policy that will not hold up to these constantly-changing animal spirits. By accepting and understanding these emotions, however, economists and policy makers can create more effective policies and plans. These policies and plans will not be permanent, however, and should change according to the cultural, economic, and emotional climates of the time.
  • 8. CONFIDENCE The amount of confidence people have has a huge influence on their economic activity. When they are confident, they go out into the world and make purchases. They are more likely to make decisions spontaneously and feel that they will instinctively be successful in their ventures. Confidence requires trust in the system, and trust in a positive outcome. As long as individuals remain trusting, they will not recognize the impulsiveness of some of their decision making. Once trust in their own success falters, however, the poor decisions they may have made are revealed and the new impulse is to sell and withdraw.
  • 9. FAIRNESS Incorporating fairness into economics involves bringing in expectations about how individuals believe others should behave because at its root, that is what fairness is all about. If someone feels that another person or institution treated him or her unfairly, he or she will become upset with that person or institution. The social psychological theory of exchange is known as equity theory , which states that on either side of an exchange the inputs should equal the outputs. This does not simply mean that the numbers on both sides add up, but takes into account many different social factors, such as the status of the individuals in the transaction or the amount of thanks given.
  • 10. CORRUPTION Many economists and politicians boast of the wonders of capitalism, and while it is an excellent economic system, it is not without its pitfalls. For while it does cater to what people really need, it also caters to what people think they need. This creates the opportunity for individuals and corporations to sell modern-day versions of snake oil, meaning products or services that advertise that they can do something that they actually cannot. While consumer protection does exist within the global economy, and particularly within the United States, it is still lacking in regards to an individual’s securities, which are their savings for the future.
  • 11. MONEY ILLUSION Money illusion affects many different aspects of the economy, especially wage contracts, debt contracts, and accounting. According to natural rate theory, all labor contracts should contain cost-of-living adjustments (COLAs), while in reality only 19 percent of all labor contracts do, and for that 19 percent, the COLAs only kick in after a specific amount of inflation has occurred, with no adjustments to wages before that point. Individuals also resist having their wages cut, even if the inflation rate is negative, because of money illusion. It does not matter that they can buy more with their money; it is the actual nominal dollar amount that matters to them.
  • 12. STORIES The human mind tends to think in stories. Individuals tell themselves stories about why they are doing something, or about what they want their lives to be like. When engaged in conversation, humans are really just exchanging stories with one another. Because of the story-based patterns of human thinking and interaction, telling individuals a story about a subject can have a strong effect on their opinion about it.
  • 13. DEPRESSIONS AND THE POWER OF CENTRAL BANKERS Central bankers, such as those at the Federal Reserve, can affect the economy in two ways. First, the Fed has a large portfolio of government bonds, which it sells and buys. If it buys bonds it spends money from the Federal Reserve account, if it sells bonds it puts money into the Federal Reserve account. In this way it can expand or contract the money supply, given that others want to buy or sell the bonds the Fed holds or wants to purchase. Second, they can expand credit by lending to banks and contract credit by allowing the repayment of the loans they have given.
  • 14. THE PRESENT FINANCIAL CRISIS AND SAVING MONEY Animal spirits have a strong effect on an individual’s desire to save. Everyone knows that saving is good, but there are still large numbers of people who do not do it, or who do not do enough of it. People often tell themselves stories that encourage them to save their money. An individual’s desire to save is also based off of the perceptions society has about his or her age or environment. For example, young people typically are not thought of as savers, while middle-aged people are. The way saving is framed also influences whether or not someone is likely to save.
  • 15. UNEMPLOYMENT AND ITS RELATION TO INFLATION Traditional economic theory states that workers should allow their wages to rise and fall with inflation, and employers should be happily making those wage changes, but in reality, the efficiency wage theory prevails because human emotion dictates most human reaction. When individuals see their wages cut, they become upset and resentful. When they are upset and resentful, their work performance goes down. Because of this, many companies actually pay their employees more than the economy dictates they have to because they are afraid of decreased work performance. This, in turn, takes money away from the company that could be spent on new positions, and results in more unemployment.
  • 16. CYCLES OF FINANCIAL PRICES, CORPORATE INVESTMENTS, AND THE REAL ESTATE MARKET Corporate investments, particularly in the stock market, are much more erratic than the GDP, and they have a large effect on the economy as a whole. Economists have tried to find a stable, logical economic reason behind the ups and downs of stock prices, but they have failed. The reason behind this failure is simply that humans’ animal spirits play too large a role in corporate investments and financial prices to be neatly categorized. People who invest in the stock market tend to invest in companies that will perform best in the short run, not in the long run. This short-term mentality contributes to the volatility of the marketplace, with people buying and selling rapidly rather than sitting back and waiting ten years for the company to grow slightly.
  • 17. ECONOMIC DIFFICULTIES FACING MINORITIES To overcome these economic differences, policies must strengthen in some areas and change in others. Affirmative action is one of the most important and effective ways to boost the economic levels of African Americans. Not only does it ensure that they are given a chance, but it also lets them know that the group they identify as “them” actually does care about the interests of African Americans. Increasing the amount of minorities who hold government jobs will also serve to help the economic interests of minorities. Lastly, more education and rehabilitation programs should be included inside prisons, to help those already incarcerated turn their lives around.
  • 18. Business Book Summaries is a product of EBSCO Publishing. The website is updated weekly with 4 to 5 new summaries chosen from among the top business books printed in the United States. For more information or to sign up for the weekly newsletter, please visit http://www.bizsum.com. ABOUT BIZSUM.COM