Animal Spirits
The concept of animal spirits refers to the way individuals arrive at financial decisions in the days of economic upheavals and ambiguity. This includes purchase and sale of securities. The term was first introduced by John Maynard Keynes, the British economist. His work of 1936 dedicated to the basis of modern macroeconomics alludes to animal spirits as personal emotions, instincts and inclinations that have bearing on consumer confidence.
In case there is a volatility on the market, animal spirits come into play acting as mental patterns that make investors function. In that sense, Keynes’ views left a personal stamp on the emergence of behavioral economics.
Historical background
The latin expression spiritus animalis dates back to 300 B.C. In fact, the concept touched upon the realm of anatomy, as well as medical physiology. So, animal spirits were used to describe a spirit featured by sensory performance, and nerve terminals in the brain that led to large scale mental phenomena, i.e. manias and histerias.
The literature has not spared this term either. Animal spirits designated patterns of physical fortitude, amusement and opulence. Therefore, a context presupposed a presence of high or low animal spirits, which had reliance on the health condition and energetic state of a person.
Essence of the concept
Nowadays, the financial industry lays down its own laws. Especially, it concerns market psychology and areas of economic activity. Thus, animal spirits correspond to the sense of confidence, aspiration, fear, or pessimistic mood that may have influence on a decision-making process in the field of finances. These factors can either boost or impede economic growth.
In case of low animal spirits, there is a chance of poor confidence standards that affect the budding market. This situation may happen even if the fundamentals are stable.
Alternatively, in case animal spirits are great, confidence of market players will also gain momentum, along with the ruling prices.
Note: animal spirits are able to have an adverse effect on the economy. So that the creation of bubbles, as well as panic selling may open ground.
Emotional behavior
The theory of animal spirits supposes that there is no need in a close analysis, as a decision-making process is premised on intuition and actions of business rivals. For instance, Keynes mentioned that in the middle of economic perturbations, irrational thinking could have a bearing on individuals serving their own interests.
Subsequently, the author claimed that attempts for evaluating the prospective yield of diverse fields, firms, or business activities using common knowledge and a fair amount of understanding bring almost no result. That’s why the only way to adopt a solution in case of ambiguity is to follow the animal spirits.
Animal Spirits today
In the past decade, animal spirits have regained traction.This is due to the fact that two well-known experts in economics, George A. Akerlof and Robert J. Shiller, collaborated and published the book about animal spirits and its influence on the economic domain, i.e. an importance of person’s psychology to universal capitalism.
Therefore, these specialists confirm that animal spirits can be significant factors but government intervention is also necessary. This is done by adopting economic policies if needed. In a reverse situation, capitalism may have free course and lead to excessive use, which was a sign of the financial crisis in 2008.
Real life examples
The dotcom boom. Animal spirits can appear as market psychology specified by a sense of alarm or avidity. That’s the state for using the term “irrational exuberance”, meaning an eagerness of investors that increases asset prices far above their fair value. Even startups holding zero profit, post higher prices. For instance, there was a crash on the stock market, when the Nasdaq index collapsed.
The Great Recession. This was a period of markets being overstretched with financial innovations. Initially, the tendency was recorded as positive, but in due course the tools were recognized as fraudulent. This is what happened with collateralized debt obligations. Thus, the confidence of market players has gone down. The move was followed by a large sell-off and, as a consequence, a market crash.
Critical judgments
In fact, the trend of investment prices to fluctuate is a key feature of animal spirits. Notably, these indicators rely on personal emotions. Anyway, some experts go negative on the theory of Keynes, as animal spirits substantially throw a wrench into the estimates of reasonableness and efficiency.
Others argue that bubbles arise from excessive interference of national banks preventing a steady economic growth and overbalancing markets. These facts emerge from libertarianism that claims for quantitative easing to be the cause of bubbles and their following destruction by stimulating inefficient investments.
