What Are Animal Spirits?
“Animal spirits” is a term coined by the renowned British economist, John Maynard Keynes, to describe how people make financial decisions, especially in times of economic stress or uncertainty. In Keynes’s 1936 publication, The General Theory of Employment, Interest, and Money, he speaks of animal spirits as the human emotions that influence consumer confidence.
Today, animal spirits refer to the psychological and emotional factors that drive investors to take action amidst high levels of volatility in capital markets. Derived from the Latin spiritus animalis, meaning ’the breath that awakens the human mind’, Keynes’s insights into human behavior predicted the rise of behavioral economics.
Key Takeaways
- Origins: Animal spirits derive from the Latin spiritus animalis, ’the breath that awakens the human mind’. Coined by John Maynard Keynes in 1936.
- Influence on Financial Decisions: Animal spirits describe how human emotions drive financial decision-making in uncertain and volatile environments.
- Market Psychology: They account for market psychology and emphasize the role of emotions and herd behavior in investing.
- Behavioral Economics: Animal spirits explain irrational behavior and are predecessors to modern behavioral economics.
- Historical Observations: Notable during financial crises, such as the Great Recession of 2007-2009.
Understanding Animal Spirits
The concept of spiritus animalis dates back to around 300 B.C., linked to sensory activities and nerve endings in the brain, contributing to mass psychological phenomena like manias or hysterias. In literature, animal spirits signified states of physical courage, exuberance, and energy.
Animal Spirits in Finance and Economics
In finance, animal spirits influence market psychology and behavioral economics, embodying emotions of confidence, hope, fear, and pessimism that affect financial decision-making. When spirits are low, confidence wanes, and markets fall despite strong fundamentals. Conversely, high spirits lead to soaring confidence and rising market prices. Resultingly, animal spirits can induce asset bubbles and panic selling.
The Role of Emotion in Business Decisions
Keynes’s theory suggests business decisions in economic upheaval are driven by intuition and competitive behavior over solid analysis. He proposed that, in uncertain environments, animal spirits guide decision-making processes, acknowledging that irrational thoughts can influence financial self-interest.
Animal Spirits Enter the 21st Century
In 2009, economists George A. Akerlof and Robert J. Shiller revived the term with their book, Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism. They argue that government intervention is crucial in managing these spirits to prevent unchecked capitalism, as seen in the 2008 financial crisis. They identify five cognitive and psychological types of animal spirits:
- Confidence
- Corruption
- Money Illusion
- Fairness
- Stories
Examples of Animal Spirits in Action
The Dotcom Bubble
Market psychology marked by greed is described by the term ‘irrational exuberance.’ The dotcom bubble saw company valuations skyrocket just by affiliating with ‘dotcom’, despite minimal earnings. The bubble burst causing a significant market decline, with the Nasdaq index falling from a peak of 5,048.62 in 2000 to 1,139.90 in 2002.
The Great Recession
Prior to the 2008-09 financial crisis, the housing market was flooded with financial products like CDOs. Initially positive, these instruments were later found deceptive, leading to lost investor confidence, panic selling, and a significant market downturn.
Critiques of Animal Spirits
Some economists argue that ‘animal spirits’ reflect how investment prices are influenced by emotion over intrinsic value, challenging the views of market efficiency and rationality. Critics, often adhering to Austrian economic theory or libertarianism, suggest that market distortions are caused by excessive governmental regulation and central bank intervention, not by mass psychology.
The Bottom Line
Animal Spirits, a concept developed by John Maynard Keynes, describes human emotions that impact consumer confidence and market psychology. This idea disrupts the usual assumptions of rationality and efficiency in economic behavior.
Related Terms: Consumer Confidence, Market Volatility, Behavioral Economics, Investment Emotions.
References
- Amazon. “The General Theory of Employment, Interest, and Money.”
- Amazon. “Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism.”
