Animal Spirits in Economics — A Revolution Case Study
The only thing to fear is fear itself.
Franklin Roosevelt
A few days ago, while scrolling through The Economist, it came across my mind to read and study the A-Z of economics. It would be an easy read, and I could finish it in a few days!
Yet, my plan changed a bit, and still, I’m in the A section trying to learn about one of the terms I read there called “Animal Spirits”.
At this point, my whole plan of finishing the A-Z of economics part is completely changed into studying the terms that interest me, and here I am talking about animal spirits in economics!
Animal Spirits is a concept developed by economist John Maynard Keynes to describe the human emotions that affect financial decision-making, including buying and selling securities, during economic stress or uncertainty.
Animal spirits refer to how human emotion can drive financial decision-making in uncertain environments and volatile times. It accounts for market psychology and the role of emotion and herd mentality in investing.
Animal spirits can significantly affect economic growth, and low spirits can lead to a fall in investment, aggregate demand, and income, like what America experienced during the Great Depression. Also, there’s another concept related to this term, known as the paradox of thrift, as described by Keynes. If people and businesses save more due to low confidence levels, it can decrease aggregate demand, causing an economic downturn.
According to the theory behind animal spirits, business decisions are based on intuition and the behavior of competitors rather than on solid analysis. This can lead to irrational thoughts influencing financial self-interests during economic upheaval. Keynes proposed that the only way people can make decisions in an uncertain environment is if animal spirits guide them.
For example, suppose people think they will experience problems related to their financial status, such as unemployment in the future, instead of believing in the possible progresses. In that case, this makes them pull back and spend less money, so earnings go down, production will be reduced, and employers will lay off their employees!
Thus if everyone saves more due to low confidence levels, which may be caused by fear of losing their job or not being able to sell their product, it can lead to a poorer situation for everyone.
The five cognitive and psychological types of animal spirits identified by economists George A. Akerlof and Robert J. Shiller include:
- Confidence
- Corruption
- Money Illusion
- Fairness
- Stories or narrative-based thinking (We tend to be motivated by stories more than what we think!)
These phenomena help economists consider answers to tricky questions, such as why economies fall into depression and why financial prices and corporate investments are so volatile.
In summary, animal spirits account for market psychology and the role of emotion and investor or consumer confidence in investing and generally purchase behavior.
I am still determining the validity of this analysis from an economic standpoint. However, based on my personal experience, I may have observed this phenomenon in Iran in 2022. I welcome any comments, discussions, corrections, or references to allow me to explore this topic further.
During my residence in Iran, simultaneous with the rise and the beginning of the Iranian revolution against the dictatorial regime for freedom in 2022, I figured out the rise of uncertainty and confidence in consumer behavior in the perfume market.
During that period, I worked as a marketing specialist for a holding company specializing in importing and producing perfume. I observed significant changes in consumer behavior within the perfume market due to inflation and a lack of confidence about the market’s future. As a result, consumers became increasingly conservative, opting to reduce spending on non-essential products. This ultimately led to a significant drop in product demand within the perfume industry. This demand downturn led to several online stores’ closures and subsequent layoffs.
Furthermore, digital marketers faced the risk of job loss during the protests due to the uncertainty surrounding internet availability. This was due to the dictatorial government’s attempt to limit internet access to quell protests. Many digital marketers lost their jobs as their employers lacked confidence in the future of the Internet and digital marketing.
In conclusion, the concept of animal spirits highlights the significance of recognizing the role of emotions and herd mentality in financial decision-making. The Iranian Revolution of 2022 serves as a compelling example of the impact of low confidence levels on consumer behavior within the market and the risk of revenue reduction in digital channels due to the unstable Internet status for employers. These factors ultimately contributed to economic instability. Acknowledging the contagious nature of confidence levels is essential, as they can propagate a domino effect that adversely affects the economy.
Therefore, understanding the effects of animal spirits is vital for mitigating their negative impact on the economy and promoting sustained economic stability.
