Animal Spirits

Animal spirits is the term John Maynard Keynes used for the instincts, moods and confidence that lead people to invest, hire and spend when the outcome of their decisions cannot be reliably calculated. Keynes argued that many important economic choices, especially long-term business investment, rest less on careful arithmetic than on a spontaneous urge to act, and that swings in this urge help explain booms and slumps.

The phrase appears in chapter 12 of Keynes's "The General Theory of Employment, Interest and Money" (1936), the founding text of Keynesian economics. It was revived in 2009 by economists George Akerlof and Robert Shiller, both Nobel laureates, and is now part of behavioral economics and of debates about why the business cycle happens.

Think about opening a restaurant. Nobody can know whether the neighbourhood will change, whether a rival will open next door or whether tastes will shift in five years. A spreadsheet can only go so far; at some point the owner simply decides to take the plunge, because they feel confident. If they feel nervous instead, they wait.

Multiply that decision by millions of business owners and households, and the national mood starts to matter. When people feel optimistic together, they invest and spend, and the economy grows. When the mood sours, they hold back together, even if nothing concrete has changed.

Keynes distinguished between risk that can be measured with probabilities and deeper uncertainty about the distant future, close to what Frank Knight called Knightian uncertainty. Because the return on a factory or a new product decades ahead cannot be calculated, he wrote, investment depends on a spontaneous optimism rather than on a weighted average of expected gains. If that optimism fades, enterprise withers even when nothing in the measurable data has changed. The term itself is much older: physicians and philosophers from ancient Greece to René Descartes used "animal spirits" for the vital forces thought to move the body, and Keynes borrowed the expression to describe the emotional side of economic action.

For Keynes, this explained why private investment was volatile and why an economy could remain stuck with high unemployment. It also supported his case for government action, through fiscal policy and monetary policy, to stabilize demand when confidence collapsed.

In "Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism" (2009), George Akerlof (Nobel 2001) and Robert Shiller (Nobel 2013) argued that standard models had stripped out psychology. They identified five forces:

• Confidence. Optimism and pessimism that spread through an economy and amplify swings, much as the multiplier effect amplifies spending.
• Fairness. Concern with what is fair, which affects how wages and prices are set and can make them sticky.
• Corruption and bad faith. Fraud and deception that tend to flourish in booms and surface in busts.
• Money illusion. The tendency to think in nominal rather than real amounts, described under money illusion.
• Stories. Popular narratives about the economy that shape behaviour, an idea Shiller later developed in "Narrative Economics" (2019).

The book linked these forces to the bubbles and crashes of the 2000s, arguing that the 2008 financial crisis could not be understood without them.

Animal spirits cannot be observed directly, but economists use proxies. Surveys of consumer confidence and business sentiment, purchasing managers' indexes, stock-market valuations and measures of policy uncertainty all capture aspects of the mood. Some research finds that shifts in sentiment help predict spending and output beyond what hard data explain; other studies find that sentiment mainly reflects information people already have about incomes and jobs. Central banks pay close attention to expectations and confidence, which is one reason they communicate their plans carefully. Investors, too, talk of risk appetite and market sentiment, sometimes swinging between fear of missing out in a rally and panic in a sell-off.

Economists in the rational expectations tradition argue that appeals to animal spirits explain too much: almost any swing can be attributed to mood after the fact, which makes the idea hard to test. They prefer models in which fluctuations arise from real shocks, such as changes in productivity or policy, and in which people use available information sensibly. Others accept that psychology matters but argue it is better studied through specific, testable biases, such as loss aversion or overconfidence, than through a broad metaphor. Supporters respond that a theory of the economy that leaves out confidence misses why crises spread so quickly, and that newer models with sentiment shocks and self-fulfilling expectations now give the idea formal content.

• Nobel Prize: The Prize in Economic Sciences 2013