|  | Authors: George A. Akerlof, Robert J. Shiller
Publisher: Princeton University Press
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Languages: English (Original Language), English (Unknown), English (Published)
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Pages: 264
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Dimensions (in): 9.3 x 6 x 0.9
ISBN: 0691142335
Dewey Decimal Number: 330.122019
EAN: 9780691142333
ASIN: 0691142335
Publication Date: February 18, 2009
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Showing reviews 51-55 of 55
 Great topic, but hastily done February 21, 2009
Nathan Fiala (Irvine, CA)
82 out of 109 found this review helpful
This book covers a number of important topics that are lacking from modern macroeconomic theory, and has come out at a time when interest in the problems with modern theory has reached a fervent pitch. Sadly though, the book is short, very unevenly written and clearly rushed to press in order to meet a new demand for answers as to why our economy is ruled less by logic than by the psychological complexities of individual people.
These criticisms are all the more interesting given that in their acknowledgments, the authors note that drafts of the book were used for the last 5 years as textbooks for a class at Yale. Surely there was enough interest in the psychology of markets, and time to finish the book, before the current crisis began.
Is the lesson to learn here that even economists who want to improve their field suffer from a laziness that permeates academia, and leads to such poor modeling to begin with?
 A major confusion over the roles of " animal spirits ",confidence,and uncertainty February 20, 2009
Michael Emmett Brady (Bellflower, California ,United States)
32 out of 47 found this review helpful
This book is worthwhile because the authors are trying to fundamentally break away from the Benthamite Utilitarian theory ( the modern version of this theory is called the Subjective Expected Utility (SEU)theory.It is a combination of the Ramsey, De Finetti,and Savage subjectivist,Bayesian approach to probability combined with the Morgenstern-von Neumann expected utility-game theory approach.SEU gives the exact same answers as given by Bentham but uses more advanced mathematics and statistics in its formulation ) that has dominated economics since Bentham wrote his 1787 book," Introduction to the Principles of Morals and Legislation ".Jeremy Bentham was the first to introduce the rationality argument of neoclassical and present day mainstream economics. The decision maker in Bentham's theory is a rational maximizer of pleasure and a minimizer of pain. This rational calculator ,or rational actor,can figure out the odds (risks) of the different ,alternative courses of action facing him in the future and pick the best one given the odds.The modern approach specifically defines rationality in the following manner. All rational decisions are arrived at by first calculating precise ,single number, additive probabilities using the mathematical laws of the probability calculus. Secondly,all outcomes are translated into point utilities using the Morgenstern - von Neumann expected utility approach. The expected subjective utility of all different courses of action are then obtained by multipling the utilities by the subjective probabilities and summing. A decision is reached by choosing the maximal expected utility.
Keynes completely rejected this approach. Keynes published his A Treatise on Probability (TP) in 1921,seven years after it was supposed to have been published. Keynes accomplished two momumental feats.First,he demonstrated that ,in areas involving decision making like social science,behavioral science, liberal arts,economics,finance,and business,sharp,precise,single number probabilities were the exception,not the rule. In general,probabilties were interval estimates that were indeterminate.They,in general, could not be made more precise or exact. Second,in making a decision ,the " weight of the evidence " ,w,defined on the unit interval in the same way probalilities were defined on a unit interval between 0 and 1,was just as important as the probability estimate in reaching a decision. The greater the body of evidence upon which the probability was based,the greater the reliability of the probability estimate. A decision maker would have greater confidence in his estimate of the probabiity, be it high,intermediate,or low,if the completeness of the evidentiary base was high and less confidence if it were low. This goes completely against the grain of the Bayesian ,subjectivist approach to probability,since the confidence of the decision maker is supposedly measured by the probability estimate ALONE. Degree of confidence and degree of probabilty are the SAME thing in the subjectivist approach. Keynes easily proved that they are different. A simple example will show this. Suppose that the probability of obtaining your goal is .9 and that this is based on 10 situations that you have examined. The probability is high but the amount of the evidence upon which the probability is based is low. Keynes would state that you will have little confidence in the high probability.Consider another goal. Suppose that you have figured out that 10,100 of the 100,000 examined situations are favorable to your obtaining your goal. The probability is low but the confidence you have in the estimated probability is high .In the GT, Keynes uses his concept of the degree of confidence in the same way as he used the weight of the evidence in the TP, as shown above.However,Keynes,instead of using weight,used the word uncertainty.High uncertainty meant low weight and low uncertainty meant high weight.None of this can fit into the standard ,mainstream view of rational decision making because only the riskiness of the outcome,its probability expressed as a second moment,the standard deviation,is taken into account.The degree of confidence or the completeness of the evidence,w, supporting the estimate of probability is not considered and can't be considered within the subjectivist, Bayesian approach.
Keynes added two other important concepts,animal spirits and conventions,when he wrote the GT in 1936. This review will concentrate on animal spirits only . Animal spirits are a measure of the degree of optimism or pessimism of the decison maker. Animal spirits should not be confused with confidence. Confidence is not one of the five different aspects of animal spirits as claimed in this book. It is a completely different variable.One need only cover Daniel Ellsberg's decision model to see this. Ellsberg's rho variable deals with the degree of ambiguity,which is very similar to Keynes's weight or the degree of confidence. An entirely different variable is used to deal with optimism and pessimism. Ellsberg has shown how to successfully integrate the Hurwicz index into a decison rule to measure the level of optimism and pessimism. Animal spirits has nothing to do with being irrational or being misguided. It measures one's emotions.Cognitive psychologists have proven that ,without emotions,NO decisons can be made,be they termed rational or irrational. The claim ,made by the authors ,that " The very term confidence-implying behavior that goes beyond a rational approach to decision making..."(p.13) is incorrect.
A number of other errors occurs with respect to the claim that Keynes was ascribing money illusion to ordinary decision makers in the labor market.This is incorrect( See pp. 42,46 ).Adam Smith is similarly misrepresented here.One only need point out Smith's extensive survey about how different societies educated their citizens to appreciate Smith's conclusion that only the government will be able to deal with the problem of educating its citizens,for free if necessary,in order to counteract the productivity diminishing ,negative externality impacts ,resulting from the alienation of the worker from his job, on the labor force through the workings of the Invisible Hand ,operating through the division and specialization of labor ( See Smith,The Wealth of Nations,Modern Library(Cannan)edition ,with foreword by Max Lerner,pp.734-741 ).
Despite many errors about both Keynes and Smith, I still recommend the book as it appears to be the only current one that is arguing for a complete reassessment of current economic practice,theory ,and policy both in government and academia.
 Parochial and overreaching February 19, 2009
a reader from 50,000 feet (U.S.A.)
25 out of 38 found this review helpful
This book ignores the one of the most important papers written on confidence, "Adaptation level and 'animal spirits,'" JEconPsych (1996), which explains powerful determinants of confidence levels as measured by the widely cited Michigan Consumer Sentiment index. This theory of animal spirits is presented in somewhat wonkish terms with a monthly forecast at http://animalspiritspage.com . It's a pity that these distinguished economists can only cite works recognized within the economics mainstream. This is especially a problem when they take on a topic that is intrinsically psychological.
As of early 2009, the good news is that American "animal spirits" are forecast to rebound from the generational lows they're at now.
Told you So: The Vindication of J M Keynes February 14, 2009
Herbert Gintis (Northampton, MA USA)
86 out of 119 found this review helpful
In his epoch-making General Theory of Employment, Interest, and Money (1936), John Maynard Keynes noted that concerning investment decisions, "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." Because of this propensity of investors to base decisions on variables other than "market fundamentals," the aggregate investment function of an economy will tend to be highly variable and erratic. Indeed, even today, it is virtually impossible to predict aggregate investment successfully, although the other sources of aggregate demand and supply are relatively well understood. Keynesian economic policy suggested that government use anti-cyclical spending and taxation to counter the vicissitudes of aggregate investment. While countercyclical monetary policy might also have the same effect via the interest rate, Keynes' theory of the "liquidity trap" suggested that investment is highly insensitive to the interest rate. Experience bears out Keynes on this point, at least for large shortfalls in aggregate demand. In an economic downturn, it is critical that the monetary authority ensure a high level of liquidity to avoid artificial curbs on the willingness of businesses to invest.
It is not hard to see that Keynesian analysis, if correct, applies to all sorts of shocks to the economy, not just fluctuations in investment. Indeed, such automatic stabilizers as progressive income taxation, unemployment compensation, and accelerated depreciation schedules can act as shock absorbers, smoothing out economic stochasticity. At least for normal-size fluctuations, active government intervention is generally ineffective because it takes the government too long to get into action, and by the time it passes the appropriate legislation, the economy has already come out the other end of the business cycle.
Keynesianism was compromised by the long stagflationary period of the 1970's: according to Keynesian theory, there is a trade-off between inflation and unemployment, whereas during this period there was both high unemployment and rampant inflation in the United States. A whole new school of "rational expectations" emerged that held that markets always are in equilibrium, unemployment was always voluntary (because all workers had to do is accept lower wages), and active government intervention is part of the problem, not the solution. While this brand of macroeconomic theorizing became dominant in the profession, it is important to understand that there is nothing in standard economic theory that proves that markets are always in equilibrium, or that they are necessarily efficient, or that regulation is unnecessary. It is true that a cabal of Chicago economists, thrust into the limelight by the electoral success of Ronald Regan, offered an absurd free-market ideology that could not be backed by solid economic theory, and was rejected by most economists.
The subprime mortgage meltdown that began in 2007 and dominates the macroeconomy today shows to the general public that the Chicago crowd was wrong, but most economists knew that all along. The really stunning fact about the current macroeconomy is that disequilibrium in the home mortgage market could so seriously compromise the American financial system. Even those who foresaw the housing crisis did not predict so massive and credit collapse, leading to levels of government intervention that would have been inconceivable in the past.
The good part of Akerlof and Shiller's book is that they show the importance not only of Keynesian animal spirits, but also other ways in which human decision-making affects the macroeconomy that violate the canons of neoclassical economic theory. I think Animal Spirits is true to the spirit of John Maynard Keynes, if not the letter, in stressing that we cannot understand the macroeconomy without having a theory of how humans make decisions.
The reader who is only interested in the current crisis and has read the New York Times or Wall Street Journal regularly will not learning anything in this book, since the current crisis is discussed in depth only in an Appendix to Chapter 7 and also in Chapter 12. However, all readers can gain from Akerlof and Shiller's defense of behavioral macroeconomics, despite the fact that most of the chapters are minor revisions of work done in the late 1980's and 1990's. The school of behavioral macroeconomics to which Akerlof and Shiller belong was waiting in the wings for a chance to tell their (compelling) story, and the current crisis is just what they were waiting for.
However, because they did not rethink their presentation in light of the current crisis, they stress some behavioral traits that are of questionable relevance, such as worker sense of fairness impeding wage reductions, and completely miss others that are absolutely key. For instance, they do not deal with public outrage at the misdeeds of the financial elite. This elite not only bribed, cheated, and covered up (in part by corrupting the accounting services and in part by creating impenetrable financial securities and peddling them as high quality), but it is making out like gangsters in the recovery. Many citizens would prefer to hurt the perpetrators (vindication is a behavioral trait the authors spend little time on) than recover from the mess we are in. Yet, rewarding the perpetrators is probably the correct course of action, as Obama seems to assume. We should remember that the Robber Barons were not despised because they were rich, but rather because they were robbers. There is some chance this new crew of robbers will get what is coming to them, and if they do, we will all suffer extra years of weak economic performance.
Even on its own terms, however, I believe that the major thesis of the book is just wrong, and certainly not proven. The authors say in conclusion that "if we thought that people were totally rational, and that they acted almost entirely out of economic motives, we too would believe that government should play little role in the regulation of financial markets, and perhaps even in determining the level of aggregate demand." (p. 173). I find this a shockingly incorrect and bizarre statement. There is nothing in economic theory that says that rational individuals interacting on markets will produce stable, efficient outcomes. The Walrasian general equilibrium model says that if there are no market externalities, there are market-clearing equilibria that are Pareto-efficient, but this model has absolutely NO attractive dynamical properties. When I subjected this model to an agent based simulation (Herbert Gintis, "The Dynamics of General Equilibrium", Economic Journal 117 2007:1289-1309), I found that there is a robust tendency towards market clearing equilibrium, but this is always offset by highly volatile stochastic movements in prices, wages, capital demand, and other macroeconomic variables. This stochasticity is due to the fact that the macroeconomy is a complex, nonlinear, dynamical system, not because of "animal spirits."
Nor do Akerlof and Shiller have enough evidence to assert confidently that people are driven by irrational animal spirits to produce market volatility. People imitate the successful. This is true, and it is generally quite rational. If someone is doing well and you are not, copying the successful is the rational thing you can do. The fact that this leads to a high degree of economic volatility implies that we must have market regulation that compensate for the tendency of people to imitate the successful rather than believing some "received wisdom" derived from so-called "rational expectations theory." Indeed, what the Chicago school called "rational" could only be defended by assuming that the whole economy could be captured by a single "representative agent." In fact, as Keynes said, the investment process is a sort of beauty contest, and this is not because people are irrational, but rather because the success of my investment plans depends on others' investment decisions, and there is no objective measure of the interpenetrating beliefs of investors.
Moreover, there is persuasive experimental evidence that even experienced subjects will produce price bubbles: see Reshmaan N. Hussam, David Porter, and Vernon L. Smith, "Thar She Blows: Can Bubbles Be Rekindled with Experienced Subjects?" American Economic Review (2008)98:3, pp. 924-937.
Akerlof and Shiller have given us a fine book, but it would be a tragedy if the debate over the renovation of the American economy revolved around the quirkiness of human decision-making, as opposed to the inherent incapacity of an improperly regulated economy to produce socially desirable outcomes.
 Absolutely great economics February 12, 2009
Jim Saunders (Fort Lauderdale, FL)
17 out of 37 found this review helpful
Shiller and Akerlof are two very prominent academic economists and they tear into some of the biggest faults in modern economics. The field has centered on things that are easy to model because models let you use impressive mathematical techniques and that lets you publish papers which help you get tenure. Writing good models is hard, but the important questions often don't lend themselves to tractable modeling and that means they often don't get sufficient attention.
Animal Spirits is a brief guide to the places where a focus on the harder-to-model aspects of human psychology play an important role in economics and the implications we derive from economic theory. They focus on four aspects of our "animal spirits":
* Confidence
* Fairness
* Corruption
* Money illusion
* Stories
And they use these concepts to explain various economic questions that don't yet have good answers. Some examples:
* Why do economies fall into depression?
* Why are there people who cannot find a job?
* Why do real estate markets go through cycles?
* Why is there special poverty among minorities?
It's a great read although a little dense at times. It's got a lot of important insights and there is a deep economics literature hiding behind their claims.
Showing reviews 51-55 of 55
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