Animal Spirits: Meaning, Definition in Finance, and Examples
John Maynard Keynes, a well-known British economist, created the phrase “animal spirits” to explain how individuals make financial decisions during difficult or uncertain economic times, including purchasing and selling assets. Keynes refers to the human emotions that impact consumer confidence as “animal spirits” in his 1936 book The General Theory of Employment, Interest, and Money.
Animal spirits are used nowadays to define the psychological and emotional triggers that cause investors to behave when confronted with high levels of market volatility. The phrase has Latin roots and means “the breath that awakens the human mind.” In some respects, Keynes’ understanding of human behavior foresaw the emergence of behavioral economics.
Knowledge of Animal Spirits
Technical references to spirit animals may be found in human anatomy and medical physiology disciplines as early as 300 B.C. Animal spirits were ascribed to the fluid or spirit in the brain’s sensory functions and nerve endings, causing widespread psychological disturbances like manias or hysterias.
Animal spirits also appeared in literary culture, where they were used to describe moods of bravery, joy, and enthusiasm. According to the literary interpretation, a person’s level of health and vigor may influence how high or low an animal’s spirits are.
Animal Spirits in Economics and Finance
The phrase “animal spirits” is used in finance today in market psychology and behavioral economics. The animal spirits represent the emotions of optimism, pessimism, fear, and confidence. These feelings can influence how people make financial decisions, which can help or hinder economic progress. Even if the fundamentals of the market or the economy are solid, a market showing promise will fall if spirits are low and confidence levels are low. Similarly, market prices will skyrocket if players in the economy have high confidence levels.
How Emotions Affect Business Decisions
According to the notion underlying animal spirits, corporate executives make judgments based more on instinct and their rivals’ actions than on thorough study. Keynes recognized that irrational notions may influence individuals’ pursuit of their financial self-interests during economic turmoil.
In The General Theory, Keynes also claimed that attempting to predict the future output of particular businesses, industries, or endeavors using general knowledge and accessible insight “amounts to little and sometimes to nothing.” He said that the only way individuals could make judgments in an uncertain situation was with the help of animal spirits.
The Animal Spirits of the Twenty-First Century
When George Akerlof, a Nobel laureate and professor of economics at the University of California, and Robert J. Shiller, a professor of economics at Yale University, published their book Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism 2, the phrase “animal spirits” gained new traction.
The authors contend that while animal spirits are significant, it is also crucial for the government to interfere when necessary to manage them through economic planning. Otherwise, according to the authors, the spirits may act independently, which would mean that capitalism might spiral out of control and lead to excessive consumption, which led to the 2008 financial catastrophe.
- The following are the five cognitive and psychological categories of animal spirits that Akerlof and Shiller recognized. These occurrences aid economists in thinking through complex issues like “why do economies enter depressions?” and “why are financial prices and corporate investments so volatile?”
- Integrity Corruption
- Finance Illusion
- Fairness Narratives
- Animal Spirits in Action: Examples
- Internet bubble
Market psychology driven by either fear or greed frequently takes the form of animal spirits. In the latter case, “irrational exuberance” has been used to characterize investor euphoria that pushes asset values much higher than the fundamentals of such assets warrant. Adding “dotcom” to a company’s name elevated its market worth to exceptional levels, with companies commanding ever-higher share prices while generating no earnings.
The Nasdaq index, which had increased fivefold between 1995 and 2000, fell by 76.81% during the subsequent meltdown, from a peak of 5,048.62 on March 10, 2000, to 1,139.90 on October 4, 2002. The majority of dotcom equities had collapsed by 2001’s conclusion.
A major recession
Another instance was the period leading up to the Great Recession and the 2008–2009 Financial Crisis when the markets were teeming with financial innovations. Both new and old financial products, including collateralized debt obligations (CDOs), were used in various inventive ways, especially in the housing market. This tendency was first viewed favorably, but before it was discovered that the new financial products were dishonest and false. Investor confidence crashed at this point, a sell-off started, and the markets crashed. Unmistakable evidence of rogue animal spirits.
Animal Spirits’ critics
The term “animal spirits” describes the propensity for investment values to fluctuate depending more on market sentiment than actual worth. However, other economists disagree with this notion, claiming that markets are still effective and that collective irrationality cancels individual irrationality. Like behavioral economics, the animal spirits thesis effectively upsets the efficiency and rationality presumptions.
Other opponents contend that rather than being the consequence of mass psychology, bubbles are caused by excessive central bank engagement and regulation, which stifle economic development and disturb market equilibrium. These arguments frequently come from libertarianism or Austrian economic theory, which contends that substantial increases in the money supply (“printed” by governments) are the root cause of bubbles and ultimately lead to their destruction through promoting malinvestment.
John Maynard Keynes, an economist, used the phrase “animal spirits” to characterize the human feelings that impact consumer confidence. These explain market psychology, particularly the influence of emotion and herd mentality on financial decisions. The notions of efficiency, rationality, and the fundamental forces guiding economic activity are all challenged by this.
- The term “animal spirits” is derived from the Latin spiritus animalis, which means “the breath that awakens the human mind.” British economist John Maynard Keynes first used the term in 1936.
- Animal spiritual ludes that human emotion may influence financial judgment in unstable situations.
- Animal spirits explain market psychology, particularly the impact of emotion and herd mentality on investment.
- Animal spirits, the predecessor of contemporary behavioral economics, explain why humans act irrationally.
- The idea of animal spirits may come into play during financial crises, such as the Great Recession of 2007–2009.