Federal Reserve Chairman Ben S. Bernanke can review John Maynard Keynes on reviving “animal spirits” after an economic slump. Or he can read the more contemporary work of Janet Yellen’s husband.
George Akerlof, a Nobel Prize-winning economist and spouse of the Fed vice chairman, co-wrote with Yale University’s Robert Shiller a 2009 book titled “Animal Spirits,” a phrase borrowed from Keynes’s 1936 work. They argued that confidence and human behavior play an under-appreciated role in driving the U.S. economy and global capital markets.
What motivates Americans to spend and lend is a key concern of Bernanke, who has said a goal of unprecedented monetary stimulus is to “increase confidence, both among market participants, but also among investors and private consumers and other people in the economy.” As consumer sentiment and home prices reach five-year highs and stocks hover near records, signs are increasing that animal spirits are awakening.
“If there’s any common theme, it’s about willingness to take risk, and a sense of optimism that I can take risk and have a chance of succeeding,” Shiller said in an interview. “Maybe the animal spirits are coming back somewhat.”
In their book, Akerlof and Shiller wrote that “there are limits to the effectiveness of such standard monetary policy when there is a loss in confidence, and businesses and consumers are loath to spend.”
The insight into their theory is even more noteworthy because Yellen is under consideration for appointment by President Barack Obama to succeed Bernanke. Akerlof, in an e-mail, declined to comment.
As the U.S. was emerging from the Great Depression, Keynes wrote that many human actions are “a result of animal spirits - - of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.”
The Fed faces a similar crossroads in the national psyche. As Bernanke and his colleagues on the Federal Open Market Committee consider whether they can begin slowing and unwinding their stimulus campaign, they’ll be considering whether improvement in the labor market can lead to a sustained period of growth.
Measures of confidence suggest a stronger outlook. The Bloomberg Consumer Comfort Index reached the highest level since January 2008 last week. The index is still lower than any reading from 1994 to 2007. The Conference Board’s gauge of consumer confidence in June recorded its highest reading since January 2008, before dipping in July.
“We’re no longer worried about Armageddon but we’re so far from the periods of out-and-out glee, of unleashed animal spirits where the future looks bright as ever,” said James Paulsen, the chief investment strategist of Wells Capital Management in Minneapolis with $340 billion in assets under management.
Rising investor confidence has helped propel stocks to record highs, with the Standard & Poor’s 500 Index closing last week at 1,709.67.
In the past year home prices have swung to gains from losses. The S&P/Case-Shiller index of property values in 20 cities rose 12.2 percent in May from a year earlier, compared with an 0.5 percent decline reported in May 2012.
While the unemployment rate fell to 7.4 percent in July as the economy added 162,000 jobs, Shiller sees the economy still at risk. The share of people with jobs, known as the employment population ratio, was unchanged in July at 58.7 percent and is lower than a record high of 64.7 percent in 2000.
“The story of our time now is that long-term unemployment remains high and the labor force as a percentage of our population has gone way down,” Shiller said. With so many Americans left behind, “the danger is that animal spirits can get much worse, and we just can’t control it,” he said.
Yellen’s speeches on monetary policy show an awareness of the people affected by central bank decisions. In a Feb. 11 speech to the AFL-CIO, the federation that represents 57 labor unions with 12 million members, Yellen noted that 15 percent of the population lives in poverty, and that three million unemployed Americans have been looking for work for one year or more.
“These are not just statistics to me,” Yellen said. “We know that long-term unemployment is devastating to workers and their families. Longer spells of unemployment raise the risk of homelessness and have been a factor contributing to the foreclosure crisis.”
She said, “the toll is simply terrible on the mental and physical health of workers, on their marriages, and on their children.”
Before leaving academia to become a central banker, she and Akerlof were frequent co-authors, publishing papers together on topics ranging from the efficiency of the labor market, to the causes of unemployment, to the reunification of Germany and the rise in out-of-wedlock childbearing in the U.S.
When Akerlof won the Nobel Prize in 2001, he wrote of their professional compatability. “Not only did our personalities mesh perfectly, but we have also always been in all but perfect agreement about macroeconomics,” Akerlof wrote in a biography published with the award.
Andrew Rose, a professor of economics at the University of California at Berkeley’s Haas School of Business who has co-written research with Yellen and Akerlof, described the symbiosis of their approach.
“George is more loosey-goosey, more casual, with flashes of brilliance,” Rose said. “Janet helps to separate the wheat from the chaff. She’s incredibly sensible and allows you to think very carefully and rigorously about the ideas. Between the two of them, they were a huge pleasure to collaborate with.”
Akerlof, 73, came to Washington with Yellen, who served first as a Fed governor, then as chairman of Bill Clinton’s Council of Economic Advisers.
“When Janet was at the Fed, I supported her as much as possible by taking over household duties,” Akerlof wrote in 2001. “Later when she was at the White House, my role in providing psychological support in the daily political storms was yet more important.”
In 1995, a year after being appointed a Fed governor by Clinton, Yellen told the Minneapolis Fed that “if you spent an evening at our house you would probably hear economics discussed over the dinner table.”
In recent years those discussions may have involved Akerlof’s work on “animal spirits,” a phrase from Keynes’s “The General Theory of Employment, Interest and Money.”
Yellen has supported, and in some cases helped design, the Fed’s efforts to respond to the most recent recession with record monetary stimulus, including lowering its target interest rate to near zero in 2008 and beginning large-scale asset purchases known as quantitative easing.
That helped stop the longest and deepest recession since the Great Depression and has allowed the U.S. to outperform the euro area, where unemployment has been at a record high 12.1 percent for the past four months.
“Europe is in recession, China is pulling back, India is weakening” and “the U.S. is doing fairly well,” Shiller said. “We’re getting better confidence relative to the rest of the world.”
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