Sunday, July 19, 2009

Animal spirits -After some reading-

In a recent post, I described a lecture given by one of the authors. After the completion of the 9th chapter out of 14 my impressions have not changed much. The book proposes some new "variables" that modern economic theory does not use. The so called "animal spirits". Defined as a set of variables such as confidence, money illusion, stories and corruption.

The approach of the book can be shortly summarized in the following: Macroeconomics has taken too far rationality assumptions. After more than 100 pages, evidence and arguments presented are in my view far from conclusive.

The authors construct most arguments based not on facts but on frequent guessing. No doubt behavioral economics rely it's findings on an interesting psychological framework. No doubt it will eventually develop to a sounder stage. But the animal spirits theory contributes little to economic modeling.

It is hard in the profession to consider seriously a theory without a model to assess reality. Not to mention in economic policy-making. The only animal spirit that could be tested at present is the one that is based in stories. Something particularly similar to adaptative expectations. The Economist magazine made available a bold description of the current state of the economist profession in terms of those soft spots of macro.

This explanation is much more centered than Akerlof and Shiller's. It states an important fact too. We economist prefer an elegant and formal theory. Not because of vanity, but because science grows based on sound facts and abstraction of them. We now know for a fact that financial markets can not regulate by them selfs. It seems that this is the most notable weakness of modern macroeconomics, not the rationality assumptions for the rest of the economic agents, nor the microeconomic foundations that modern macroeconomist agree are important. Including recent advances of the Dynamic Stochastic General Equilibrium Models.

The article of the Economist says also, that we consider only theories that can be modeled. That is true. Again not for vanity but for its usefulness for real life problems. An example. Keynes's breakthroughs in economics translated in to reality with a deep and a comprehensive fashion until Hicks developed the IS-LM model, until then, keynesian theories were only provocative philosophical arguments.

Maybe behavioral economics will provide the theory for serious improvements of macroeconomic theory. The Animal Spirits book does not provide a model for this end.

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