Abstract
This book written by Robert Shiller and George Akerlof deals with our misunderstanding of the last crisis inherited from the collapse of the subprime market. Despite some precursor signs, nobody expected it. According to the authors, the last crisis (and the resulting recession) appeared unexpected because we always neglect the importance of animal spirit and more generally the place of human being in the economic theories.
Akerlof and Shiller aim at restoring ‘from the intellectual history bin’ (p. 6) the (old) Keynesian concept of animal spirit in order to improve our understanding of the last global crisis. Of course, the book, as many others, deals with the current recession, however it can be distinguished from other works because it offers a normative perspective about the way of developing economic theories.
Beyond the scope of the book, Akerlof and Shiller claim for a theoretical revolution in economic theory. As Keynes reminded us in 1936, academics and policymakers should restore the place of individual psychology (even if it looks irrational) if we want to understand how economic phenomena works and then improve our ability to forecast the potential emergence of a crisis. In this perspective, Akerlof and Shiller use the contributions developed in cognitive psychology and behavioural economics.
As they suggested in the title of their book, the authors emphasize the key concept of ‘animal spirit’. By animal spirit one should understand ‘the state of mind which is underlied by any intellectual and emotional mechanisms, (p. 9). More precisely, in the chapter dedicated to this concept, authors show how ‘animal spirit’ is closely linked with the notion of ‘confidence’. Through this concept of confidence, the authors focus on the individuals’ decision making process which is not totally governed by perfect rationality (as is often presupposed in the economic theory). In a sense, the authors hold that the history of capitalism is more a thorough study of the individual ‘mind’ rather than a study of economic policies or quantitative theories. More precisely, this spiritus animalis can be seen as the power of the mind which is the prime mover of human actions. Such approach is clearly based on a theoretical view opposite to liberal Smithian traditional approach according to which the economic equilibrium would be the result of agents’ perfect rationality. Authors implicitly claim that, till date, economic advisors and policymakers have been blinded by the liberal theories and the idea that market efficiency is possible, thanks to the hypothetical perfect rationality of individuals. The last crisis reminds us of the limits of such a framework. In line with Keynes and his ‘General Theory’, Shiller and Akerlof claim that time has come to restore the place of individual psychology and social behaviour in economics.
The added value of the book relies on its ability, without using a mathematical argumentation, to survey most of the main macroeconomic issues such as unemployment, monetary policy, place of the State, consumption and saving decision making process and so on. In this perspective, this book aims to reach a very large audience of people interested in economics.
Through the 13 chapters, Akerlof and Shiller successfully show that psychology and confidence had been (and still are) at the roots of the economic decision making process. The book focuses essentially on the financial and monetary crisis over the last decades (mainly in Chapter 3). Such historical survey sustains the main idea of the authors according to which the so-called animal spirit played a key role in each financial or real estate speculative bubbles. Most of the crisis we observed (the 1890 depression, the 1930 Great depression, the 1987 crash or more recently the subprime crisis) often started from a lack or an excess of confidence or from corruption. In order to take into account the importance of this animal spirit, Akerlof and Shiller introduce a new confidence multiplier deriving from the well-known concept of Keynesian multiplier. They define this new multiplier as ‘the impact on income of a unit of confidence (whatever in the case of one unit more or one unit less)’ (p. 26). This new concept is then applied to the subprime crisis. Because of an excess of confidence towards the real estate sector, every agent created a ‘myth’ or a ‘fantasy’ on the ability of the real estate investments to create wealth. We should mention that not only agents were responsible but the economic and banking institutions had their part of responsibility since they massively sustained the mechanics of the ‘subprime’ credit or the ‘securitization’ process and its derivatives (ABS or CDS). Even if this securitization process can be rationally justified (since this process is based on the idea of diversification of risk), it gave an illusion about the way of creating wealth by diluting risk.
According to Akerlof and Shiller, Chapter 7 is the cornerstone of the book because it proposes new ideas for monetary policy (p. 107). Monetary policy should rely on a stronger discretionary power of the central bank through its standing facilities. By referring to the history of the Federal Reserve System1, Akerlof and Shiller remind us that the primary objective of a central bank is to provide liquidities in short-term in order to prevent systemic crisis. In this perspective, a central bank is the ‘monetary and financial fireman’ thanks to its lender of last resort function (such as in the LTMC crisis in 1998 or more recently in the subprime crisis). For authors, standing facilities of central banks should be the leading instrument for monetary policy while open-market operations should then be considered as secondary. However, as emphasized by authors, most of the current central banks in the world (mainly the Fed, ECB or Bank of England) take the opposite monetary strategy.
From Chapter 8 to Chapter 12, the book surveys the main macroeconomic issues through the development of the leading Keynesian concepts. We regret that the authors add nothing new about these major issues. For instance, the explanation of unemployment is derived from the theory of wage efficiency and from wages’ stickiness arguments both in theory and practice. We observe the same thing with the monetary illusion topic. Nothing new is said unless the affirmation that monetary illusion matters both in short and long runs (contrary to the dogmatic vision developed by the mainstream theory which denies this monetary illusion).
The authors clearly aimed to reach a large audience. That is the reason why their book is mainly based on examples rather than on theoretical argumentation. However, while it can be seen as a key point, the heterogeneity of the subjects dealt with is the weakest point of the book. In fact, most of the main macroeconomic topics are presented in a general way and no real demonstration is proposed. Considering the background of the authors, we also regret the lack of practical recommendations2 concerning policy. As a consequence, we think that the academic audience will probably expect a deeper analysis than the one proposed in the book. In a sense, this book must be seen as a manifesto to a more realistic economics which would take into account the complexity of human behaviour. The leitmotiv that could summarize the book would be as ‘everybody can trust in capitalism but not in a self regulating capitalism’. When markets fail to perfectly coordinate agents’ allocations, state regulations remain necessary. In this context, Prof. Keynes still seems to contribute the more as an economic advisor even in the twenty-first century.