Understanding our animal spirits

Prof Shiller (remember him from “Irrational Exuberance) has partnered with George A Akerlof in a strangely titled new book: Animal Spirits. I’m recommending it even before reading it.

It’s basically about why we don’t behave as rational consumers when faced with economic choices.

If you don’t want to wait, then there’s an excerpt from the book – the first chapter, which you can read over at Yale MBA’s Financial Crisis website.

Here are the five animal spirits – emotive things that often dictate our economic behaviour.

• The cornerstone of our theory is confidence and the feedback mech­anisms between it and the economy that amplify disturbances.
  
• The setting of wages and prices depends largely on concerns about fairness.
• We acknowledge the temptation toward corrupt and antisocial behavior and their role in the economy.
• Money illusion is another cornerstone of our theory. The public is confused by inflation or deflation and does not reason through its effects.
• Finally, our sense of reality, of who we are and what we are doing, is intertwined with the story of our lives and of the lives of others. The aggregate of such stories is a national or international story, which itself plays an important role in the economy.

Just those five statements make for interesting pondering – so here is my quick take.

Confidence is everything – it is the difference between buying something (on credit even) and choosing to hunker down and not spend. When a depressed or optimistic feeling rolls out to entire populations then it causes and exacerbates busts and booms.

It’s true that we care most about parity and fairness when setting wages and paying prices. This is particularly evident in New Zealand where we tend to look down at those with unhealthily large incomes and spending habits and where we have a nationally loved TV program called Fair Go that goes after companies that rip people off. Interestingly the feeling of fairness to members was the overriding thing that governed our thinking in the days when I was involved in setting prices at Trade Me.

We also score pretty well as a country on corrupt and anti-social behaviour – scoring at of near the top of the list in the annual Transparency International surveys as a result. On the other hand we are a little divergent on our strong norms about what is anti-social behaviour – though we tend not to shoot each other and mostly we don’t rip each other off.

It’s true that we all tend to compare our income now to our income years ago, and fail to understand that $1m now is worth a whole lot more than $1m at retirement. This is the money illusion – where we look at the dollar figures and not at the real worth, the nominal not the real. Having grown up through inflationary times it did improve my own approach to this versus, say, my grandparents generation who often didn’t change the dollar value of their Christmas presents to grandkids (mine were a bit different). The trick is to constantly reset the current value of everything.

Finally I am guessing “stories” refers to the formal and informal coverage of things like bubbles and busts. Everyone was talking up dot coms in 2000, real estate in 2007/8 and stocks in 1929.  Fast forward a couple of years and the picture was (and will be) diametrically opposed – the media coming down hard on what were correctly seen in hindsight as speculative investments. I try to be contraian, using taxi drivers and ultimately my mother as the unfailing barometer – if Mum says buy, then I go ahead and sell.

They use these five animal spirits in the rest of the book to answer eight questions – such as why do economies fall into depression and why do real estate markets go through cycles?

Interesting stuff to be sure – I recommend just reading the first chapter and having a ponder – the answers may not be that difficult to work out, and if we can be internally aware of those “animal spirits” then perhaps we will make better decisions.

Now I need to decide where to buy it from. Fishpond don’t have it but Amazon who do. However I am really annoyed with them as most of the things I want (electronics, accessories) are not shipped to New Zealand.