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Tuesday, January 27, 2009

Animal Spirits and Trust

I've never been a big fan of the animal spirits story of business cycles, but Robert Shiller believes that "Animal spirits offer an explanation for ... why the economy fluctuates as it does":

Animal Spirits Depend on Trust, by Robert J. Shiller, Commentary, WSJ: President Obama is urging Congress to pass an $825 billion stimulus package as soon as possible. But even that may not be enough to stabilize the economy, since it fails to take into account the downward spiral of animal spirits...

The term "animal spirits," popularized by ... Keynes..., is related to consumer or business confidence, but it means more than that. It refers also to the sense of trust we have in each other, our sense of fairness in economic dealings, and our sense of the extent of corruption and bad faith. When animal spirits are on ebb, consumers do not want to spend and businesses do not want to make capital expenditures or hire people. ...

Animal spirits offer an explanation for why we get into recessions in the first place -- for why the economy fluctuates as it does. ... A critical aspect of animal spirits is trust, an emotional state that dismisses doubts about others. In talking about animal spirits, Keynes sought to convey ... that swings in confidence are not always logical. The business cycle is in good part driven by animal spirits. There are good times when people have substantial trust... They make decisions spontaneously. They believe instinctively that they will be successful... As long as large groups of people remain trusting, people's somewhat rash, impulsive decision-making is not discovered.

Unfortunately, we have just passed through a period in which confidence was blind. It was not based on rational evidence. The trust in our mortgage and housing markets that drove real-estate prices to unsustainable heights is one of the most dramatic examples of unbridled animal spirits we have ever seen. ...

The danger at this point is that ... confidence will continue to plummet. ... So what must we do to revive our animal spirits...? We must be certain that programs to solve the current ... crisis are large enough, and targeted broadly enough, to impact public confidence. Not only do we need a fiscal stimulus significantly greater than the proposal ... currently on the table, government action is also needed to take the place of the credit markets... The Treasury and the Federal Reserve not only need a fiscal target, they also need a credit target. This should not be a dollar number, but rather a target for how the credit markets should behave. The goal should be that those who would normally receive credit in times of full employment can once again find it easy to do so...

The interventions so far have been in the right direction. Federal Reserve Chairman Ben Bernanke has been especially inventive and aggressive. But ... a great deal more still needs to be done. Now is not a time for the timid. ...

In due course our animal spirits will once again turn positive, but we would rather that happen this year or the next rather than five or 10 years from now. There is only one way to speed this process: greatly expand governmental support of credit markets and pass a much larger fiscal stimulus plan than is now proposed.

    Posted by on Tuesday, January 27, 2009 at 12:51 AM in Economics, Policy | Permalink  TrackBack (0)  Comments (50)


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