Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism by George A. Akerlof and Robert J. Shiller

This entertaining book takes up the theme that psychology matters for economics. Akerlof and Shiller introduce this idea in the guise of 'animal spirits' that they define to mean five things: (1) confidence (beliefs about what will happen can independently influence outcomes); (2) fairness (wage setting depends on concerns for what others receive); (3) antisocial behavior (some bankers are criminals); (4) money illusion (people are confused about money prices versus real prices); and (5) stories (people believe what friends and the media tell them). In the first five chapters, the authors elaborate on each of their five meanings of animal spirits. In the following eight chapters they use their ideas to address eight different questions ranging from why economic depressions occur to the state of poverty amongst minorities. A recently added postscript to a chapter on the power of central bankers presents their solution to the current financial crisis. I will make three points in this review. First, although there is much to be said for the authors' proposal that psychology matters, their definition of animal spirits is far too broad. In spite of its faults, there is much to like about neo-classical economics, and jettisoning almost all of it at once, as the authors do in this book, will be too radical for many, including myself, to accept. Second, there is an extensive existing body of research, developed over the last 25 years, that integrates animal spirits into economics using a much narrower definition than the one proposed in this book. 1 This body of research achieves most of the goals of Akerlof and Shiller without giving up on the idea of rational behavior. Third, although the authors are on target in their attack on orthodoxy, they do not provide a credible alternative theory to classical or Keynesian economics. Instead, their policy advice is based on Keynesian ideas that were tried and failed in the 1970s. Let me start by defending neoclassical theory, which, in spite of its many faults, also has many successes. At the core of neoclassical economics is the idea of rational choice. Akerlof and Shil-ler want to replace rational choice with behavio-ural economics, an approach that argues that psychological (and in some cases neurological) evidence can be used to judge the validity of economic theory. Behavioural economists assert that what makes individuals truly happy can be different from what they in fact choose to do. …