Animal Spirits

Definition

Animal spirits refer to the emotional factors that influence economic decision-making and drive economic activity. It is a concept introduced by the renowned economist John Maynard Keynes, who believed that human psychology and sentiment play a crucial role in shaping economic outcomes, beyond just rational economic considerations. The term 'animal spirits' suggests that economic agents, such as consumers and investors, are not always driven by purely logical and calculated decisions, but are also influenced by their emotions, intuitions, and spontaneous urges. This can lead to fluctuations in economic activity that cannot be fully explained by traditional economic models.

5 Must Know Facts For Your Next Test

1. Animal spirits are a key concept in Keynes' theory of the Keynesian Perspective on Market Forces, which emphasizes the role of psychological and emotional factors in shaping economic outcomes.
2. Keynes believed that animal spirits can lead to fluctuations in investment and consumption, as economic agents may make decisions based on their emotions and intuitions rather than purely rational calculations.
3. The concept of animal spirits helps explain why economies may not always reach full employment equilibrium, as proposed by classical economic theory, and why recessions and booms can occur.
4. Animal spirits can lead to herding behavior, where economic agents follow the actions of others, contributing to the formation of asset bubbles and financial crises.
5. Policymakers may need to consider the role of animal spirits when designing economic policies, as traditional policy tools may not be effective in addressing the emotional and psychological factors that influence economic decision-making.

Review Questions

• Explain how the concept of animal spirits relates to the Keynesian Perspective on Market Forces.
  • The Keynesian Perspective on Market Forces emphasizes the role of psychological and emotional factors, or 'animal spirits,' in shaping economic outcomes. Keynes believed that economic agents are not always driven by purely rational considerations, but are also influenced by their emotions, intuitions, and spontaneous urges. This can lead to fluctuations in investment, consumption, and overall economic activity that cannot be fully explained by traditional economic models. The concept of animal spirits helps to explain why economies may not always reach full employment equilibrium and why recessions and booms can occur, as economic agents may make decisions based on their emotions and sentiment rather than purely logical calculations.
• Describe how animal spirits can contribute to the formation of asset bubbles and financial crises.
  • Animal spirits can lead to herd behavior, where economic agents, such as investors, follow the actions of others rather than making independent decisions. This can contribute to the formation of asset bubbles, as investors may buy assets based on the belief that prices will continue to rise, rather than on the underlying fundamentals. When the bubble eventually bursts, it can lead to a financial crisis, as the sudden drop in asset prices can have widespread economic consequences. The concept of animal spirits helps to explain why these types of irrational economic behaviors can occur, as they are driven by the emotional and psychological factors that influence decision-making, rather than purely rational considerations.
• Analyze how policymakers might need to consider the role of animal spirits when designing economic policies.
  • The concept of animal spirits suggests that traditional economic policy tools may not be fully effective in addressing the emotional and psychological factors that influence economic decision-making. Policymakers may need to consider the role of animal spirits when designing policies aimed at stabilizing the economy and promoting economic growth. For example, policies that focus on boosting consumer and business confidence, rather than just manipulating interest rates or fiscal measures, may be more effective in addressing the emotional and psychological factors that drive economic activity. Additionally, policymakers may need to consider how their own actions and communications can influence animal spirits and the overall economic sentiment, and tailor their policies and messaging accordingly. By understanding and incorporating the concept of animal spirits into their policymaking, policymakers may be better equipped to address the complex and dynamic nature of economic behavior.

Related terms

Uncertainty: The state of not knowing what the future holds, which can lead to hesitation and caution in economic decision-making.

Confidence: The level of optimism or pessimism that economic agents have about the future, which can influence their willingness to spend, invest, and take risks.

Herd Behavior: The tendency of economic agents to follow the actions of others, rather than making independent decisions, which can lead to irrational bubbles and crashes.