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Friday, November 14, 2008

Shiller: Our Animal Sprits are Weakening

Robert Shiller says restoring business confidence is the key to economic recovery:

Reviving the Animal Spirits, by Robert J. Shiller, Commentary, Project Syndicate: The world's fundamental economic problem today is a staggering loss of business confidence. Commercial banks, investment banks, and hedge funds all owe their ongoing trouble to its decline... Our "animal spirits," to borrow a phrase made famous by John Maynard Keynes, are weakening. ...

This decline in confidence is fundamentally related to the chaos in the financial markets that started in 2007 and accelerated this September. The specter of collapsing financial institutions.., and desperate government bailouts to try to save them, has created a general sense of alarm.

Then there is the effect of memory on today's animal spirits. People know enough about the Great Depression to understand that there are parallels with today. ... Beyond that, national leaders are defending extraordinary bailout measures by not-so-veiled comparisons to the Great Depression. ...

The erosion of animal spirits feeds on itself. Immense market volatility serves only to reinforce people's sense that something is really wrong. A volatility feedback loop begins: the more volatility, the more people feel they must pay attention to the market, and hence the more erratic their trades.

Perhaps the saving grace in this situation is that animal spirits can and sometimes do change direction. Confidence is a psychological phenomenon, and can make seemingly capricious jumps up as well as down. The most promising prospect for a return of business confidence now would be some kind of public inspiration. In the US, President-elect Barack Obama seems to have the charisma to create this, and his status as the first minority president marks a major historical transition that might have great positive psychological impact in the US and around the world.

Whatever the near future holds the multitude of plans now being discussed to deal with this global crisis need to be judged with attention to the elusive and inexplicable effects they might have on confidence. The "animal spirits" that Keynes identified generations ago remain with us today.

    Posted by on Friday, November 14, 2008 at 12:24 AM in Economics, Financial System | Permalink  TrackBack (0)  Comments (28)

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