A note on Keynes' Animal Spirits

A note on Keynes' Animal Spirits

First draft

By Hans O. Melberg

In The General Theory Keynes made the following arguments:

"Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than mathematical expectations, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as the result of animal spirits - a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities." (161-162)

"... human decisions affecting the future, whether personal or political or economic, cannot depend on strict mathematical expectation, since the basis for making such calculations does not exist ... it is our innate urge to activity that makes the wheel go around ..." (p. 162)

These paragraphs raises (at least) as many questions as they answer. It is clear that Keynes believes economic fluctuations can be partly explained by spontanous (or exogenous) shifts in moods (optimism or pessimism). The causal chain form the change in moods to economic fluctuations, is not through changes in the expected utility of different alternatives, but through the degree to which we want to act or be passive. It is, however, very unclear to what extent it be said that "animal spirits" explain fluctuations as long as Keynes is so vague about the nature of these spirits. The phrase "a spontaneous urge to action rather than inaction" is not very helpful. It may help to explain why we did something, but it does not explain why we picked one particular act out of the many possible "somethings" we could do. In short, to fill the term with more operational content we need to do some exegetical work trying to reveal exactly what Keynes meant.

The secondary sources differ rather strongly in their interpretation of animal spirits. Roger Koppl (1991, p. 205) writes that Keynes believed that "the actions induced by animal spirits are irrational." He also argues that Keynes' use of the term was probably inspired by Descartes who (according to Koppl), believed that blood that was heated in the heart and transported to the brain could be "animated" and as such make the person "act contrary to their best judgment."

In contradiction to Koppl's interpretation, Alexander and Sheila Dow (198?, p. 52 Keynes methodology?) claim that explanations based on animal spirits do not imply irrationality:

"If evidence is scant for the propositions put to business decisionmakers, then they may legitimately weigh them lightly as offering little in their way of prescience. This behaviour is wholly rational, as is the use of direct knowledge (such as business intuition) in such circumstances."

Moreover, the central idea, according to Down and Down, is that uncertainty makes "the state of confidence" important and opinions on this fluctuates wildly since it is based on flimsy evidence (see esp. p. 49). Thus, the action is not contrary to our own judgment - as Koppl suggests - since no reliable judgement is possible.

A third article on animal spirits reveal further disagreement. While Down and Down (p. 50) counts Keynes' article from 1937 as evidence of "the central importance of confidence and animal spirits in Keynes' eyes", R.C. Matthews (1984, p. 210) makes a point of the fact that the term animal spirits was not mentioned in the 1937 article. Matthews also present detailed evidence on the origins of the term. Apparently Keynes first heard about it in a lecture in Modern Philosophy about Descartes (as Koppl rightly guessed, but should have known) and other philosophers. In his lecture notes Keynes wrote the following comment in the paragraph about animal spirits: "unconscious mental action" (Matthews, p. 212). Matthews then goes on to distinguish between "the motivational aspect (corresponding to animal spirits) and the cognitive (corresponding to the response to uncertainty)." (p. 213). The key idea, he believes, is the suggestion that "the motive from economic behaviour arises from doing as well as having, from becoming as well as being" (p. 214).

There is, in other words, disagreement on whether it is rational be inspired by animal spirits and there is disagreement on exactly what animal spirits are. The origins of the confusion may be endogenous to Keynes's own arguments since he himself seems to present contradictory interpretations. The relevant chapter in The General Theory (ch. 12: The state of long term expectations) is about "some of the factors which determine the prospective yield of an asset" (p. 147).The argument is based on the assumption that "our knowledge of the factors which govern the yield of an investment some years hence is usually very slight and often negligible." (149):

"If we speak frankly we have to admit that our basis for knowledge for estimating the yield ten years hence of a railway, a copper mine, a textile factory, the goodwill of patent medicine, an Atlantic liner, a building in the City of London amounts to very little and something nothing ...)"(p. 149-150)

This means that the participants on the stock market have to rely on "convention" to reevaluate investments. The "essence" of this convention "lies in assuming that the existing state of affairs will continue indefinitely, except in so far as we have specific reasons to expect a change" (p. 152). But, since our knowledge is so weak, the state of confidence is low and the investment market is precarious (see 153-158 for the detailed reasons why he thinks the market is precarious, for instance the short term views of traders and the beauty contest problem). Keynes then goes on to distinguish between speculation (buying based on hopes of increased value) and enterprise (based on estimates on prospective yield of asset, p. 158). It is only towards the end animal spirits are introduced, in a paragraph opening with the following words: "Even apart from the instability due to speculation, there is instability due to the characteristics of human nature..." (p. 161). These characteristics (the desire to do something) lead us to ignore the risks of loss and "keep the wheels turning." In short, the chapter is mainly about speculation and uncertainty and animal spirits are included only towards the end as an additional variable to explain instability.

In what sense are Keynes' suggestions contradictory? Keynes cannot at the same time argue that the key driving force is animal spirits (as opposed to cold calculation) and that fluctuations are explained by the flimsiness of the calculation behind the asset value. Consider the following quotations:

"... it is probable that the actual average results of investments ... have disappointed the hopes that prompted them ... If human nature felt no need temptation to take achence, no satisfaction (profit apart) in constructing a factory, a railway, amine, or a farm, there might not be much investment as the result of cold calculation." (p. 150)

"Opinions as to their [capital assets] prospective yield are themselves subject to sharp fluctuations, precisely for the reasons already given, namely the flimsiness of the basis of knowledge on which they depend." (Down p. 51, from 1937 article).

Either we calculate and the fluctuations are caused by the fact that these calculations have weak basis, or we do not calculate and fluctuations are caused by variations animal spirits (not through calculation). It is the same confusion that leads to Koppl and the Downs to different conclusions about the rationality of animal spirits. If we really are completely uncertain (the first quotation), then it is no less rational to be guided by animal spirits than to base your actions on your (non-existent?) subjective beliefs. If animal spirits make us act despite our beliefs (the second quotation), then it suggests irrationality (which is collectively beneficial in this case). The argument that Keynes himself was not very clear in chapter 12 is further strengthened by information from Richard Kahn who says that the chapter was "not subject to the scrutiny of the group of younger colleagues assembled by Keynes to help him" Mathews p. 210, note 2)

In sum, the attempt to use Keynes's idea about animal spirits to provide a behavioural foundation for a theory about economic fluctuation does not seem very promising. This may reveal a major problem with the behavioural approach (lack of precision and formal modeling since optimization is not the basis), but it would be to commit the fallacy of composition to generalize from only one example.

References

Down, Alexander and Sheila (198?), Rationality and Animal spiritsm in Lawson (?) ed.: Keynes Economic methodology /incomplete reference ... sorry)

Koppl, Roger (1991): Retrospectives: Animal Spirits, Journal of Economic Perspectives, 5 (no. 3), 203-210.

Matthews, R. C. O. (1984): Animal spirits, Proceedings of the British Academy, 70, 209-229.