Feb 15 2009
David Ignatius’ recent column (Washington Post, 2/8/09) highlights an interesting aspect of Keynesian theory on the occasion of its recent resurrection due to the financial Panic of 2008 and the election of President Obama: the idea that “psychology matters in economics.”
At 21stCenturyWaves.com, intimate connections between psychology and economics are an integral aspect of our Maslow Window model, in which twice-per-century major economic booms do two things: 1) result in wide-spread affluence required to fund large-scale engineering activities, and, more importantly, 2) create affluence-induced ebullience which briefly elevates many people to higher levels in Maslow’s hierarchy. Ebullience and elevated Maslow states create an almost giddy atmosphere of social well-being and confidence vital to undertake and support large, risky, multi-year exploration and technology programs. The confluence of societal affluence and ebullience is seen infrequently in modern times, when unparalleled booms in economic activity triggered the four great explorations (Lewis and Clark, Dr. Livingstone in Africa, the Polar Expeditions, Apollo Moon) of the last 200 years.
John Maynard Keynes is famous for advocating a policy of combating recessions (i.e., smoothing the business cycle) by increases in government spending to stimulate aggregate demand in the economy. The “stimulus packages” are the largest examples in history of Keynesian policy in action. However, Ignatius also points out that Keynes was the “godfather of behavorial economics” and sought the underlying causes of booming economies. Keynes called them “animal spirits,” — powerful emotions which motivate investors’ actions.
According to Dick Armey (Wall Street Journal, 2/4/09), Keynes greatest contemporary critic was Nobel economist Fredrick Hayek, who believed that Keynes’ fundamental flaw was he “assumes that government knows better how to spend and invest than individuals acting in their families’ best interest.” Despite the Obama administration’s energetic assurances that huge stimulus bills are essential today, this controversy persists; e.g., 200 economists recently signed a letter asserting that “government spending by Hoover and Roosevelt did not pull the U.S. economy out of the Great Depression of the 1930s.”
Regardless of which side of this political dispute you inhabit, our purpose here is to look more closely at Keynes’ concept of “animal spirits” and how it applies to 50+ year long waves in the economy.
In his 1936 book (General Theory of Employment Interest and Money) Keynes puts it this way, “Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits – a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.”
In other words, key business decisions are not always rational — the result of mathematical probabilities — but are somewhat emotional, intuitive assessments of business trends at any instant. In 1996 Alan Greenspan referred to these waves of optimism (and sometimes pessimism) as “irrational exuberance.”
Yale economist Robert J. Shiller (Wall Street Journal 1/27/09) believes that animal spirits depend on trust. “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 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…”
The last 200 years of macroeconomic data and historical trends document the clustering of great explorations and macro-engineering projects (MEPs) in brief periods (i.e., Maslow Windows) during (and just after) major, twice-per-century economic booms. Keynes’ concept of “animal spirits” and Greenspan’s “irrational exhuberance” seem similar to the even more energetic “affluence-induced ebullience” believed to fundamentally motivate great explorations and MEPs during the brief, but spectacular Maslow Windows of the last 200 years.