Wednesday, July 1, 2009

Animal Spirits -A First Glance-

Berkeley economics' professor George A. Akerlof and Yale's Robert J. Shiller recently published a book that awake interesting feedback so far. The title reads "Animal Spirits" invoking a popular phrase of J. M. Keynes regarding the underlying factors that come to play when it comes to investment decisions.

This already shows some biased in the convictions of the authors, which can be summed up in the following: governments should play a more active role in the economy than free-market advocates claim.

I have not read the book yet -I will soon- however, I have a clearer picture of its contains. Shiller visited recently the LSE and gave a lecture on it. One of the central points made was that, unlike we economist assume, individuals make decisions based in shakier, less technical premises. One in particular caught my attention. Akerlof and Shiller state that individuals base their decisions in "stories". This is, in someone else's experiences. Frankly, this falls in place if we look to how investment decisions are made in cities like Guadalajara, in Mexico.

It is fairly common to hear that someone decided to get in the carwash bussines because he heard how well someone else was doing. It is easy to replicate the latter in mobile phone stores, haircutt shops, caffe internet, real state buying, and so on. There are no feasibility studies behind, just stories from acquaintances.

Of course, it is true that not only Guadalajara corroborates Akerlof and Shiller's hypothesis, just as is true that there are hundreds of counter examples. Nevertheless, the "stories" story seems a lot like the forgotten adaptative expectations. So, in a way, the authors suggest that models -such as the modern macro models- should be re-assessed to include the latter and delete the "rational" approach.

This is my hope at least, otherwise it would be hard to model those indivuduals' "animal spirits". Still, there is some reading to do.


Salvador Rodrigue said...
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Salvador Rodrigue said...

These kind of facts are present in everyday situations. Adaptive expectations are usual in agricultural decisions. I also think that another problem is related to the quality of economic information previously supplied before the burst of the markets (as happened in "The Panic of 2008"- labeled by Governor Kevin Warsh). So, economics models with predictive power will be achieved by incorporating better adaptive expectations as suggest you, imperfect information, and maybe another considerations as probability distribution assumptions (to limit the impact of “Black Swans”), temporal dynamic dimesions; a better toolkit to deal with these events.