Animal Spirits - Akerlof and Shiller

August, 2009
I read a great book, Animal Spirits, by George Akerlof and Robert Shiller. This is a sample of what I learned.


Robert Shiller:
He specializes in behavioral finance, real estate and risk management topics. He was an early challenger of the Efficient Markets Theory.

George Akerlof:
He wrote the famous article “The Market for Lemons” about asymmetrical information. He also won the Nobel prize – how impressive!
Shiller is an economist at Yale and he is the Shiller part of the Case-Shiller Housing index
Akerlof is an economist at Berkeley. This book is essentially a rebuttal to the efficient market theory. They examine the current economy and explain that psychological causes – “Animal Spirits” helped to bring about the mess we are in.


First they define “Animal Spirits” and then formulate eight relevant questions and answer them. The five aspects of animal spirits are confidence, fairness, corruption, money illusion and stories.

Confidence: this brings us back to the multipliers we learned about in macro class, i.e. there is a ripple effect when people do or do not feel good about the economy and act accordingly
Fairness: this explains why wages and prices move slowly
Corruption: acceptance of corruption waxes and wanes in our society and the economy is affected
Money Illusion: people forget and/or do not take into account inflation when making decisions
Stories: we tell ourselves stories about what is going on in the world: they may or may not be true, but they become our perception

The eight questions are very good:
1. Why do Economies Fall into Depression?
2. Why do central Bankers have Power over the economy?
3. Why are there people who cannot find a job?
4. why is there a tradeoff between Inflation and Unemployment in the Long Run?
5. Why is saving for the future so arbitrary?
6. Why are financial prices and corporate investments so volatile?
7. Why do real estate markets go through cycles?8. Why is there special poverty among minorities?

The answers:

1. Economies from time to time experience fundamental changes in confidence.
2. They are the guardian of the money supply and the bank of last resort.
3. Wages are not efficient
4. Because of money illusion
5. Lack of a savings policy in the U.S.
6. Because of markets
7. The confidence multiplier in real estate
8. Lots of history to overcome


The real value of this book is to give us a reason why the financial crisis and subsequent downfall occurred. Then the logical conclusion is what we can do to prevent such a debacle again.

Important Sidebar: The Case-Shiller Index
What is it? Also known as the Case Shiller Weiss index. There are actually many indices. They are composites of single-family home prices in 20 metro areas in the United States. Fiserv now own the indices and publishes them monthly. There are options and futures based on the indices. Why is it useful? Just as the Dow and the S&P500 averages are used by many as a general indicator of the movement of the overall stock market, the S&P/Case-Shiller U.S. National Home Price Index can be used as a general indicator of the real estate market in the United States. When were real estate prices the highest? In Q2 of 2006. The index has declined ever since.