Animal Spirits: A Q&A With George Akerlof

It’s safe to say that macroeconomists haven’t been very popular lately. In fact, many people blame the profession for such sins as failing to predict the housing bubble and encouraging the deregulation of the financial industry.

In their new book Animal Spirits, the economists George Akerlof and Robert Shiller propose a new macroeconomic framework — one that incorporates real human behavior, with all its quirks and irrationalities. The book explores the intersection of economics and psychology and offers valuable insights into a variety of important economic policy issues.

George Akerlof, who teaches economics at the University of California, Berkeley, was awarded the 2001 Nobel Prize in Economics for his work on asymmetrical information markets. He has agreed to answer a few of our questions about the new book.


What are animal spirits?


In The General Theory, written in the 1930’s at the heart of the Great Depression, John Maynard Keynes described the reasons that businessmen make investments largely psychological. He said that they could not really assign the probabilities to various outcomes, such as the success of a new ocean liner or a new coal mine, but instead they had to act on their intuitions, or their “animal spirits.” In our book Animal Spirits, Robert Shiller and I broaden Keynes’s concept to refer to psychological motivations more generally. We discuss five of these that are especially relevant to how the economy behaves. They are confidence, corruption and bad faith (or “snake oil”), fairness, money illusion, and stories. We show how these animal spirits lie at the heart of eight basic economic questions, which are as fundamental as why the economy fluctuates as much as it does, why monetary and fiscal policy affect output and employment, and why there is involuntary unemployment.


In your book, you examine the causes of past depressions. Why do economies fall into depressions?


There can be many reasons why economies fall into depressions, but we think that the most major cause for depressions has been loss of confidence, usually associated with a financial collapse. They both feed into each other: the financial collapse feeds into the loss of confidence, and the loss of confidence feeds into the financial collapse; and both in turn also feed into reductions in output and employment.

These financial collapses are preceded by a period of overconfidence (of high animal spirits). In this period, investors and consumers are very trusting. They make incautious investments. In these times there are quick profits to be made from initiating financial investments for a quick profit and then passing them on to others. We call this the selling of snake oil. There are also stories regarding why this is a new era and there are special profits to be made. People and the press act on these stories and pass them on to one another.


We have to ask: as a Nobel Prize-winning economist, what do you think should be done about the financial crisis?


We should have two targets: a target for aggregate demand and a target for credit. These targets force policy makers to have their eye on the ball. In the first target, there should be sufficiently large stimulus to aggregate demand that the economy would have at full employment. There should also be a credit target so that those who are doing legitimate business (not selling or buying snake oil) would be able to obtain loans under reasonable terms (on the terms they would normally obtain if the economy were at full employment and credit markets were operating normally).

For most important journeys, one of the most important decisions is the destination. By establishing and aiming for such targets (they are destinations for economic policy) the government will be able to plan sensibly. Roosevelt and Hoover had many programs. They were both very inventive about what to do in the Great Depression. But because they lacked firm targets, they were never sufficiently confident. The Depression could have been cured easily with an appropriately large dose of fiscal stimulus, but it was not applied. Unemployment in the United States only fell below 10 percent in 1941, which was some time after the start of the war in Europe, in September 1939. World War II, unfortunate as it was, then provided the fiscal stimulus that got us out of the Depression.


You argue that humans’ propensity toward fairness can cause higher than expected rates of unemployment. Can you explain this?


Employers are reluctant to hire people at wages that employees consider to be unfair. What manager wants to deal with grumbling workers? But such wages may be higher than the wage at which employers would want to hire all those who are seeking jobs. The difference between those who want the jobs at these wages that employers pay and those who have jobs will be the unemployed.


The current financial crisis has demonstrated the importance of national savings, yet people don’t seem to make rational decisions about personal savings. Can animal spirits shed some light on how people make savings decisions?


We economists are very proud of our theory of savings. It is called “the life cycle theory,” where people rationally save when they are young for their future consumption in retirement. There is a great deal of truth to this point theory, and it conforms to the facts. People in their middle years tend to save, and then older people dis-save in their retirement. But this theory does not explain why there is great variation in savings across countries. These differences, which vary from the almost zero saving rate of the U.S. to the almost 50 percent saving rates of Singapore, must be explained by differences in human psychology.


The economics profession has faced a lot of criticism in recent months for its failure to predict the financial meltdown. Can an understanding of animal spirits help economists avoid such a mistake in the future?


We should be able to do much better in the future. We should have known that complex financial instruments that were potentially unbacked could lead to business failures and the break-up of financial markets.

But now we understand that with animal spirits, people will incautiously buy inadequately backed securities if they are overconfident. Insurance is regulated so that if your house burns down, the insurance company will have the money to pay. The same should be the case of other financial assets: they should be regulated so that people’s expectations will be met regarding whether or not they will be paid off. The mortgage market is only one financial market where people showed overconfidence. There was much greater need for regulation of financial markets.

Bobby G

Keynes mentioned in the first sentence of his response, eh?

I don't mean to be a harsh critic but when I read their "animal" behaviors, "confidence, corruption and bad faith (or “snake oil”), fairness, money illusion, and stories," I just think these are fancy ways of saying "risk assessment and incentive structures." In the final answer, I would disagree that insurance companies are (or at least should be) *regulated* to pay... in fact that is their private market business structure. Why does the government necessarily have to get involved?

I guess I just get put in a sour mood when I read things that imply "encouraging the deregulation of the financial industry" is a bad thing. Everyone who says that (and there are many), I believe, doesn't understand what happened to our economy.

Brad Harbach

"Where people rationally save when they are young for their future consumption in retirement"

I'm fascinated with how backwards our conventional savings patterns are. Why is it that we choose to make sacrifices during our years of greatest health and ability to provide us with opportunity during our years that we are least able to fully take advantage of it?

As a young American in my twenties I'm surrounded by others who choose the unfullfilling pattern of slaving five days a week at work to enable them to spend the weekends out at the bars and ultimately hope to save a few bucks each week to enable them to fulfill all of their lifelong dreams once they retire at 65. Why do we foolishly all believe this is the good life?

As an example: Everyone dreams of traveling - "some day I want to go to ". Why can't we learn to live life now instead of always procrastinating all of our lifelong dreams until retirement? I've written about overcoming your fear of LIVING NOW and I think it offers some good advice to help you get out of always living for the future.



Animal spirits? The answer to rebuilding macroeconomics is incorporating the irrational psychology of animals? I can appreciate the application of economist's tools to psychology (freakonomics), but this would appear to be the application of dead psychologist's tools to economics. I find it absolutely terrifying that economist's appear now to be on the path of re-hashing early 20th century theory. Good luck with worked so well the first time. Here's a clue: Behaviorism was the spark that led them out of that hole towards something with some kind of practical value...


>>I don't mean to be a harsh critic but when I read their “animal” behaviors, “confidence, corruption and bad faith (or “snake oil”), fairness, money illusion, and stories,” I just think these are fancy ways of saying “risk assessment and incentive structures.”<< I have not read the book, but I think it's trying to make precisely the opposite point: Risk assessment and incentive structures are fancy ways of saying fear and greed (animal spirits). My personal opinion is that this is probably correct. I do not know any completely rational human beings, so it is not obvious to me that economic models based on completely rational economic actors will accurately reflect reality. It's kind of like building fluid dynamics theory by assuming only laminar flow – it might look like real life under a very limited set of conditions, but it's going to miss some very interesting and important effects.



@Bobby G

"In the final answer, I would disagree that insurance companies are (or at least should be) *regulated* to pay… in fact that is their private market business structure. Why does the government necessarily have to get involved?"

Because if it's not regulated, it isn't really insurance. An unregulated insurance company will go bankrupt if they are hit with more claims than expected. If they can't pay you when you make a claim, then you didn't really get insurance, did you? If it's not regulated, it ends up being fraud (more or less) and we end up where we are now.

If credit default swaps were regulated like most insurance is, then when the mortgages went bad, there would've been sufficient funds to cover the losses and no crisis. They weren't though, so it wasn't really insurance. It was warm fuzzies and vague assurances to pay that weren't really backed by anything.

ali b

Brad Harbach is absolutely right. We all need a good life now.
I notice that people from Germany and Sweden are able to travel and have some free time to improve themselves with study or hobbies. They have a safety net that will care for them in old age if necessary.

Bobby G

@ Leo (#4),

Reflexive property. The point was they are the same thing, and that there is no "novel" idea about calling these influential factors by different names. Not to mention words like "risk assessment" and "incentive structures" have existed long before "animal spirits."

I don't like the excuse you give about rationality. Just because sometimes people are irrational doesn't mean being rational is not better. It is always better, for you, to act in your own self interest... by definition! If (as economics dictates) acting in your own self interest can, in fact, benefit others (think mutually beneficial trade, one of the most basic economic concepts), and, on a larger scale, rationality can benefit an organized economy, shouldn't we then promote rationality?

Free market economics inherently punishes irrationality; those acting irrational will lose money (and thus economic power and influence) to those acting rationally. Thus there is a cost to acting irrationally and a benefit to being rational. I feel like this is a very healthy innate incentive structure that is only skewed by government intervention. While market failures do exist, permanent (seems like it is anyway) government intervention is never the absolute instant fix.

I know in reality people are irrational. I do not think that gives us the excuse to reward irrationality, however. (Evidently, in this country, a lot of people do.)

And P.S., Brad, being in my 20s as well I can appreciate your point, but good luck trying to start a life and/or a family at age 30 or 35 having been out of school without a career for 10 years and competing against the "fresh young minds" aka overachievers of the day. I wish the world operated like the way you say but it doesn't, and pretending it does will put you at a very real disadvantage later, and may possibly affect the opportunities and benefits that you can only experience when you are older (think family and friends). That being said, the reasons you list are my validations to not worrying about my money too much today, but I do consider working to be very important for long term career development.


Bobby G

@noah (#5),

Apologies for the double post, but you're wrong.

"An unregulated insurance company will go bankrupt if they are hit with more claims than expected."

That is not regulation, that is insurance (yes, on an insurance company), and that is a different topic. And bankruptcy is not fraud as you imply. I think transparency would be the best solution... if you want insurance, there's demand for insurance, and as a consumer you will shop around for both the best price and the best quality (i.e. the firms that handle money the best and are least likely to go bankrupt if you need to file a claim). I don't see a real market failure here, and I don't know why the government should need to *regulate* the industry, nor even why they need to financially back it. Let people who invest irrationally suffer, let those who make good decisions benefit.

As for your second point, I think the real problem was over-valuation of those assets due to very poorly managed, already existing government regulation (federally-backed Fannie and Freddie who purchased pretty much any mortgage that applied... hey if you can reap all the profit and all the cost goes to the taxpayer, why wouldn't you?). Just like with the insurance company explanation above, if people were allowed to value mortgages and securities in a pure free market (not one inflated by the government-backed firms with a seemingly unlimited demand, thus driving up prices and inflating profits for everyone), there would be no financial problem. Once again, people who made bad investments would suffer, and people who made rational investment decisions would profit. That's the way it should be in my mind... I want to be rewarded for being smart, I don't want to have to pay taxes to support the people who weren't smart (yet who stood to make a ton of money anyway).



Bobby G (#7)

>>Not to mention words like “risk assessment” and “incentive structures” have existed long before “animal spirits.”< < I'm just going to have to disagree with you on this one. “Animal spirits” is a pretty old term that existed long before this book and long before economics. The idea that people act on emotions similar to that experienced by animals is a pretty old one. You're right that there's no novelty in this, except that it removes the illusion that behavior is exclusively the result of rational analysis. >> I don't like the excuse you give about rationality. Just because sometimes people are irrational doesn't mean being rational is not better.< < I actually agree with you that being rational is almost without exception better than being irrational. However, I disagree that economic theory should be telling people how to behave. In my opinion, the purpose of theory (in any field) is to help us understand reality. In cases where theory conflicts with reality, theory should be modified in order to reflect reality better. If I understand you correctly, you seem to want theory to tell people how to behave. Personally, I don't like that any better than I like the government telling me how to behave. >>Free market economics inherently punishes irrationality; those acting irrational will lose money (and thus economic power and influence) to those acting rationally.<< I think you're making a very ideological statement here that is generally unconvincing to people who don't share your ideology. I can think of several irrational decisions that I made which turned out to be quite lucrative for me. So at best, the statement has to be modified to “the free market *tends* to punish irrationality” although I'm not even sure about that one. For one thing, although rationality may be the *best* approach, it still doesn't guarantee that yields the *correct* answer. The history of science is full of examples where the perfectly rational hypothesis turned out to be utterly wrong.


Bobby G


As for "animal spirits," I've never heard the term used in an economic setting and I tend to think of humanity as pretty different from the rest of the animal kingdom myself, so while I can understand that there are some similarities, applying animal idealogy to *national* *economic* *policy* (all three of those words do not exist in any animal context) seems a little absurd, when we already have words that describe human behavior just fine.

I'm not sure how theory can tell anyone anything. Theory is... well... theory, it is not an entity. My argument about influencing behavior is in fact that I want the government to influence as little as possible. Natural factors (i.e. rationality) influence it well enough, and if you read the blog post you'll realize that the author is in favor of increased government stimulus (and taxes) to further distort the free market. I, on the other hand, am vehemently opposed, believing that the free market has enough incentives in place to influence behavior in a manner positive to the economy.

I'm not really trying to convince anyone of anything. Your scenarios of an irrational decision that benefitted you doesn't prove that irrationality is better than rationality, more that you didn't know you were not acting in the most rational manner (I guess...) and you got lucky. If it was, say, more profitable to do activity X, then it is rational to do activity X, regardless of why you actually did it (in other words, it doesn't matter WHY you did it, but coinciding with the rational decision is just as efficient as acting rationally). A person's assessment of what is rational is, again, a different debate altogether, but the absolute rational thing to do is always always always the best. An economy should always reward people who make the best choices (regardless of why). Failures in "perfectly rational hypotheses" indicate that, clearly, those hypotheses were not rational and that they were based off of incomplete information or some error.

This is getting way too philosophical here. I just want the government to stop creating incentives to punish people who are self-interested, rational, and successful, that's all.



I have to disagree with their last answer. I think you need to factor in "herd mentality". Humans are very influenced by what others do. When risk takers have a high chance of failure (with successful outliers), most will not be risk takers. Likewise, when risk avoiders get little or no upside, most will find a middle ground.
But, when risk takers are doing very well, most will be drawn to that success, and diminish their fear of risk based on following the herd. This applies not just to individuals, but managers/CEOs as well. Think about it, if other banks are making a fortune with exotic loans and you (as a bank) are not, you are now outside the herd - you are more likely to move to doing the same. Individuals do because they do not want to be left out either.
Likewise during recessions and depressions. When many are very risk-averse, others want to be in the herd and will be risk averse (not spend as individuals, not loan as banks, not invest, etc).
The herd mentality is made stronger by the enormous number of sources of information we have now. Most news channels, magazines/newspapers, blogs, etc will highlight success stories during bubbles and will highlight failure stories during downturns. This makes it easier to know if you are inside the herd or outside.


Ed Hamilton

Clean the system -- ask them all:
In your opinion,
will asset-market extreme mispricing be well-deterred,
if and when
real inflation-adjusted asset-market price histories
are well-apparent to the people?

Illustrate the Q&A: Shiller has such (roller-coaster!) histories charted in the book Irrational Exuberance, both editions. And see such in the first chart here:
“Real Dow & Real Homes & Personal Saving & Debt Burden” at



So you are against regulation and feel inclined to criticize those who are considering irrational behavior in the markets?

What evidence do you have that freemarket would actually work as you feel it would?

In the current situation I could invest in a money market account(low interest safe investment) with a bank that lends to those institutions that have leverage of 35 to 1. Who are insured by individuals that have no money to back their insurance. All this is caused by the unregulated issuance of insurance(CDO/CDS) and folks who underwrite mortgages with no responsibility to cover said bad debts in the future.

So how is self interest supposed to save me from this situation? I've in essence chosen the lowest risk available and yet have no recourse against irresponsible behavior by said institutions.

Self interest is actually self delusion. I sell you insurance that can't be covered by the insurer, for loans that can't be paid and think that I will get interest for money that I've invested? All this is because each individual is acting in their own self interest.

Your logic is inescapably flawed. Self interest means that people will do anything to achieve their ends, which also means that they will not regard the integrity of the system in which they operate, which means that the system is inherently unstable, which means that a completely unregulated market is in fact unstable.

I'm sure you have a rebuttal for this so fire away.


Mojo Bone

Boil it all down to fear and greed? At least it's an explanation I can be content with. In the absence of fear of regulators, blind greed guts the global economy, which is based on little else but confidence-the engine that drives the creation of wealth. Problem is, I thought all that was well understood after the Great Depression. An adversarial relationship between government and business has long been the hallmark of socialist political parties-it is one of the duties of government to protect persons from corporations. I would argue that the current crisis of confidence began not with the mortgage meltdown, but with 9/11, when we learned that the government couldn't or wouldn't protect us from terror; and with Katrina, when we learned that business couldn't or wouldn't protect us from the financial consequences of natural disaster. But imho, the insurance industry is and has always been a classic case of information asymmetry, so I'm not sure why we should have been surprised..



These are presumably non-quantitative theories.
This may have advantages over quantitative modeling
which omits terms reflecting psychology simply
because they are hard to pin down (Merton, Scholes;
Nobel Prizes and the demise of Long Term Capital Management).


Notwithstanding the value of examining the intersection between psychology and economics, you could provide an even more comprehensive and insightful understanding of economics and economic behaviour by bringing in economic sociology. This latter field is making major contributions to our understanding of economics without the strong ideological overlay so typical of standard approaches economics. Some names you might want to consider are Richard Swedberg, Mark Granovetter and Frank Dobbin to name just a few sociologists making major contributions working in this area.


I have to disagree with the assessment that employers' value on "fairness" leads to unemployment because employers don't want to pay employees what they consider to be unfair wages. in reality, there are many other factors involved, none of which have to do with fairness. namely, there are other costs associated with paying employees very low salaries (high turnover, etc). employers are willing to pay more than the lowest possible wages because it makes good business sense, not because of their 'animal spirit' of fairness.


On Animal Spirits . . . think of logical types, eg whitehead, russell, bateson, and dilts. Technical assessment is a different logical type than "animal spirits" assessment. The "animal spirits" are values and their related beliefs (implied not stated), "confidence, corruption and bad faith (or “snake oil”), fairness, money illusion, and stories". Both levels are involved, both are useful, both have explanatory value, but with using only one for an "assessment" , the assessment will be lacking in ways that using both logical levels will not.

One of the problems with capitalism is is has as the holy grail only one value: Profit. The profit motive may be most efficient in moving macro economic dimensions around, eg, the means of production capital, labor, and management, but it does not address micro economic issues which result from values other than "profit". Nor does it address costs such as dirty air, water, and costs to the community which are not captured in the financials of a firm.

That is the role of governing in our modern society.



Singapore's savings rate - mentioned here as close to 50% - is not out of choice. Singapore requires all those in salaried employment to contribute to the Central Provident Fund, from where the individual accounts can be drawn down only to (a) buy property, (b) certain shares - usually of state-backed large companies, (c) gold, or (d) to be drawn down as de facto pension upon reaching a certain age limit. This figure is close to 30% of an employee's monthly salary. Economists have often questioned whether this sort of compeled-savings is justified; left to themselves, people may spend their money differently. (The Fund to which contribute, incidentally, provides resources for the state to build infrastructure, among other things, and some economists have shown that the return it earns on those investments trumps the interest the state pays the individual savers - in other words, Singaporeans are subsidizing the state, by offering the state cheap funding, so that the state can spend it the way it wants.



I've just ordered this book and am waiting for it with great interest. I cannot argue on the economic theory, not being an economist, but what I can certainly attest to is how psychological the drop in consumer confidence has been in this recession, aided and abetted by the alarmist news media. I am conducting an experiment to see if it is possible to boost consumer confidence by creating a pro-shopping movement targeted at those who still have plenty of disposable income, but who have somehow become convinced that frugality is the new cool.