Monday, September 10, 2012

Animal Spirits - Geroge A. Akerlof and Robert J. Shiller

Animal Spirits was released in the aftermath of the 2008-09 financial collapse. However, contrary to most of the books on finance and economics released at the time, Animal Spirits is not a direct product of the crisis. Its authors, George A. Akerlof and Robert J. Shiller, had been working on it since 2003, when few people were talking about the bubble in the real estate prices. In fact, Animal Spirits is more a divulgation of Keynesian theories than a "recipe" on how to deal with the financial crisis.

The website of the book presents how many prizes it received, and most of the reviews I found in Google are positive (here Is a negative one!). Freakonomics interviewed Akerlof as the book was released. The core argument of the book is that the economic cycle is governed by "animal spirits" (i.e., irrational impulses), which are not taken into account by economic classical and neoclassical theory. The policy solution proposed by Akerlof and Shiller is a strong regulating state that tames animal spirits when the cycle is in bubble territory, and encourages them when the cycle is in a depression. An ideal version of this proposal would finish the cycle altogheter, since the state would keep a vigilant eye on markets and would not allow them to deviate from trend.

Lets accept for one minute the hypothesis of animal spirits as valid. In that case, I am afraid that a strong state would not be the solution to violent cycles. Regulators get captured very easily -most of the times without actually realizing it, as Simon Johnson and James Kwak argue in 13 Bankers and continue to show in Baseline Scenario, one of the favorite econ blogs of your writer. If traders and bankers are prone to let animal spirits rein, so are their regulators, if nothing else because they were all educated in the same framework. If they exist, animal spirits will continue being part of finance and economics and regulation is not the solution, at least not in its entirety; other parts include the break down of the financial institutions that are too big and too interconnected to fail. The problem is not that banks (including shadow banking) go bankrupt, but that there are so few and large, that if one falls down, the entire system collapse.

In short, this is a good book to get a better understanding of Keynes thought (his original texts are incomprehensible). Non-specialized readers will understand most of it, but the goal market is senior econ students -previous versions of the book were used as texts in classes by Akerlof and Shiller.

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