Irrational Exuberance Writ Large

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Indeed, one alternative to the Akerlof-Shiller theory is that, prior to the recent meltdown, investors, consumers, and businesses simply made a mistake when faced with the complexities of globalization and technological change.

Animal Spirits is filled with provocative ideas, some of which are not fully developed. Early in the book, Akerlof and Shiller put forth the notion of a "confidence multiplier." In their view, just as government spending can have a wide-ranging impact on growth—the so-called fiscal multiplier—government actions to boost confidence can have an impact that far exceeds the original effort. But after introducing the concept, the authors do little with it. When they offer solutions for the current crisis in the postscript to chapter 7, the term doesn't appear. Instead, they advise policymakers to aggressively push credit into the economy, as the Fed and Treasury have already been doing. These actions are necessary, they say, to take the place of parts of the financial system handicapped by negative animal spirits. Perhaps, but it leaves open the issue of whether government can directly boost confidence.

The authors' overarching message is that government needs to act forcefully to tame animal spirits, almost like enforcing rules on a child. In fact, they think government should follow the model in parenting books that advise being neither too authoritarian nor too permissive. Given the depth of today's downturn, such a prescription may find a highly receptive audience.

Mandel is chief economist for BusinessWeek.

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