How animal Spirits point the way to behavioural economics

Keynes seemed to use odd terms such as sticky prices and animal spirits.

The notion of animal spirits was just as important to Keynesian analysis as sticky wages and prices. He uses the term to mean the emotions humans feel when making decisions. Economists prior to Keynes, and the current UK Conservative government consider humans to make rational decisions in their best interests. If this was the case almost no one would vote Conservative.

It's not a made up term, it does show Keynes philosophical leanings and it's straight out of the Eton/Cambridge thoroughbred stable.

The term animal spirits was first known to be used about 300BCE. It's from the Latin spiritus animalis and it means 'the breath that awakens the human mind'. In Roman anatomy, it refers to what they thought was fluid surrounding nerve endings and can result in events like mass mania and mass hysteria, human herd behaviour.

The term animal spirits doesn't appear in psychology or consumer psychology but it does figure in finance. It represents emotions like hope and confidence, fear and pessimism. It's also considered to be socially infectious so a mood can be generated among a group or even a large section of the financial sector. Whether the collective mood is high or low can affect the decision making in investment and banking. The mass mood can act against logical expectations. Mistakes are made because of 'animal spirits' acting contrary to common sense.

Keynes knew this and knew the same herd behaviour can happen to consumers. This is one of the reasons he realised the classical laissez faire economic ideology that had preceded his theory was wrong (and is wrong today)

Keynes was pointing the way to behavioural, economics and consumer psychology. A low or pessimistic mood would now be called cognitive dissonance.

Two contemporary American economists, Akerlof and Shiller recommend governments take 'animal spirits' into account in their economic planning. They present strong Keynesian arguments in their 2009 book, Animal spirits how human psychology drives the economy and why it matters to global capitalism. (quite a title for a best selling book).

The two foundation stones of Keynesian economics

Demand is key not supply. 

Wages and prices can be slow to adjust to change.

Keynes explained why recessions occur and put forward a set of measures to keep an economy on an even keel. Earlier economists thought the market would balance the ups and downs of business cycles and the market should be left alone to work through what Adam Smith called the invisible hand. Keynes disagreed with this and argued that recessions can turn into depressions and become permanent.

Two foundation stones of Keynesian theory.

1. Aggregate demand (AgD) might not be enough to allow firms to employ people resulting in layoffs and high levels of unemployment. 

Aggregate demand is the total demand for products and services in an economy including consumers, business and government.

2. The macroeconomy (the whole economy) adjusts slowly to the reduction in demand because wages and prices are 'sticky'. Demand falls but wages and prices tend to stay the same and this fuels even more job losses and makes a recession worse.

These two factors can set a downward spiral in motion.

How did GDP (gross domestic product) start

 The term and economic measure GDP (gross domestic product) was first used by the United States Commerce Department in the 1930s during the depression.

It was first put to full working use during WW2 by British and American economists, including Keynes. 

Keynes played a major role in both WW1 and WW2. In WW1 he put forward the argument that the war should be held at the stalemate it had become. Germany blockaded from all sides and starved into surrender. This actually happened Germany faced starvation and famine as a result of the blockade. Keynes' economic warfare plan was put into action, minus the stalemate and millions of young men died.

In WW2 GDP was used as a measure of production capacity.

The economists were given the job of analysing if an all out war like WW2 was viable. They used GDP as a primary measure of economic activity in the analysis of the viability of war.

They all agreed that war, for America at least, whose economy boomed during the war is economically viable.

basic keynes

Basic Keynes and MMT

Keynes disagreed with 19th century 'classical' economics that had failed

He said firms would not invest in a recession because demand was too weak. Businesses cut investments rather than take advantage of lower wages and costs. He said once a recession sets in the gloom will make things worse.

He proposed the government should stimulate consumer spending. Consumer spending would create demand known as aggregate demand.

He argued the government borrow to stimulate demand. When governments spend more than they receive in tax it's called deficit spending and most governments do this.

The aim is to spend, (or invest) stimulate demand, stabilize the economy and bring it out of recession.

Modern Monetary Theory (MMT)

MMT argues governments with a fiat currency and central bank can always repay deficit spending.

(Tories have been levelling down Britain since 1689)

why there's never been a free market and never will be

     cash in hand is the nearest to a free market and even this is regulated

Markets have been regulated from the beginning.

Markets other than barter that use some form of exchange require a formal financial system to regulate the flow of savings, investment, the amount of exchange (money) in circulation, its value and its manufacture.

According to classical economics, interest is supposed to balance the demand for investment and savings. Therefore interest should fluctuate with the supply and demand of investment. This can't happen in practise under a system of financial control.

Savers reduce their current spending ability in anticipation of the need for money in the future. This means savers need liquidity. (Will Hutton, The Revolution That Never Was)

Investors need long term stability or illiquidity of money provided by savers.

This and other factors will lead to crises. When the financial system hits a big enough crisis the state steps in. The first measure the state will take will be to adjust interest rates. Next, it will increase or decrease the money supply.

The fact that markets need a formal and regulated financial system and that the financial system needs state aid from time to time means there can only be a limited free market. The market is limited in scope and time.

Markets are inherently cyclical becoming freer on the upswing and more regulated on the downslide.

Keynes recognised this.

Keynes wasn't the first to record this, a few years earlier Marxist economist Michel Kalecki wrote an analysis almost identical to that of Keynes' General Theory (An Attempt at the Theory of the Business Cycle 1933).

The British economist Alexander Cairncross was a student of Keynes and he advised the Chinese government how to build the successful demand based economy they have now. The Chinese government may call themselves communists but they operate a solid Keynesian system. The demand came from Britain and America. 

The growth and success of China is a direct result of Thatcherism

In Britain ex-bankers like Sunak and Javid, who should know better, are harking back to the failed and failed again 19th century ideology that we can still call Thatcherism.

Why no 'common good' hinders Keynesian measures in UK and US

 

A problem with introducing Keynesian or socialist measures in the UK is there's little to no experience of the 'common good'.

Any notion of 'common good' in the UK is the sum of private gain, commercial interest and individual actions.

The underlying 18th/19th century based ideology of the British is individualism, individual action and individual responsibility. This was exported with even more veracity to North America.

The writers whose work explored the concept of individual action and rational individual decision making have become the cultural norm. This is the case even though their ideas are generally relegated to their historical time and context.

There's a group of alt-right think tanks in the UK and the US who firmly believe in this defunct ideology and the notion of free markets that go with it. Most of the current government ministers are products of and have been spawned into leadership positions from these alt-right groups. The 

The UK is in a dangerous situation because we need to pull together but the government is encouraging us to pull apart.

Should Labour help the LibDems win more seats?

During the early years of the Labour Party, Labour and the Liberals cooperated to win parliamentary seats. The small group of Labour MPs cooperated with the liberals in Parliament against the Tories. Did they co-operate too much?

Ben Tillett thought so. he said the party has no teeth no claws and has lost its growl.

He argued that labour should stop supporting the liberals (so much) and start fighting unemployment.

Ramsay MacDonald at this time was a kind of secretary chairman and I think an unofficial leader. his strategy was to help the liberals so that the liberals would help labour get more MPs in the future. In this way, the Labour Party would have a much bigger representation in Parliament.

Perhaps McDonald's strategy worked?

I wonder...

Did Ramsay MacDonald have a bigger input to the development of the Labour Party that he's given credit for?

Would Ben Tillett's observations be quite pertinent now?

Should labour help the liberals again, in reverse this time? That is should Labour help the liberals get more MPs where they have a better chance of ousting a Conservative?