Tuesday, February 24, 2009

Animal Spirits Explained (Not Yet)

I still find the New Keynesian approach for short term output fluctuation is one of the finest theoretical explanation. You can find the summary of their research in chapter 6 of the standard Romer's Advanced Macroeconomics. Their models are so cool in explaining the seemingly irrational behavior that was not yet elaborated in the old Keynesian school.

But against the backdrop of current crisis, Akerlof and Shiller in their latest book Animal Spirits, want to move further. They argue that New Keynesian approach is good to explain the small fluctuations, but not a deep crisis. Instead they believe that animal spirits --Keynes' phrase for irrational behavior- is responsible for such exuberance, booms, and eventually bust.

They offer some working proposition by describing five aspects of animal spirits: confidence, fairness, money, illusion, corruption and anti social behavior, and stories (or narrative).

Alas, until the end of the book, I fail to grab a coherent theoretical construct, or even its prospect. They, less fruitfully, go back to old battle by bashing new classical approach and, this is rather disconcerting, relying too much on anecdotal evidence. Plus some I-told-you-so tone.

Akerlof's paper on the market of 'lemon' is one of my favorite model. And I certainly expect more with his credential, including winning the Nobel. But maybe winning Nobel is a bad signal nowadays (think of Stiglitz and Krugman).

I am still looking forward from them, though, that eventually, a neat theory of animal spirits in macroeconomics come up and stands up for academic test. And they can take their time to do this, without hurrying to publish a book just to catch up with daily conversation topic at the moment.

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