Mon, Nov 17, 2008 - Page 9 News List

Reviving ‘animal spirits’ to raise confidence

By Robert Shiller  /  STAFF REPORTER

The world’s fundamental economic problem today is a staggering loss of business confidence. Commercial banks, investment banks, and hedge funds all owe their ongoing trouble to its decline, which in turn is jeopardizing the plans of companies and entrepreneurs to launch enterprises and make investments, and of households to consume.

Our “animal spirits,” to borrow a phrase made famous by John Maynard Keynes, are weakening. George Akerlof and I have just written a book by the same name, but by the time Animal Spirits appears later this winter, the world economy may be even worse than it is now.

Nations everywhere are starting to implement aggressive stimulus and bailout packages. Yet the economic outlook still looks grim. The IMF’s latest forecast predicts that the world’s advanced economies will contract 0.3 percent in next year — the first such shrinkage since the end of World War II.

Part of the difficulty of contending with a crisis of confidence is that it is hard to quantify confidence in the first place. The Conference Board Consumer Confidence Index in the US, begun in 1967, fell last month to its lowest value ever. The latest Nielsen Global Consumer Confidence Index, which covers 52 countries, fell to 84, from 137 when it was launched in 2005.

But these surveys, which tabulate quick answers to simple questions, do not tell us how deeply held these opinions are, how new circumstances might change confidence, or what people will really do when they make important decisions in coming months or years.

This decline in confidence is fundamentally related to the chaos in the financial markets that started last year and accelerated this September. The specter of collapsing financial institutions around the world, and desperate government bailouts to try to save them, has created a general sense of alarm.

Then there is the effect of memory on today’s animal spirits. People know enough about the Great Depression to understand that there are parallels with today. Many know that interest rates on three-month US Treasury bills became slightly negative in September — for the first time since 1941.

People are also aware that the stock market has not been this volatile since the Great Depression (with the single exception of October 1987). Beyond that, national leaders are defending extraordinary bailout measures by not-so-veiled comparisons to the Great Depression.

Animal spirits are not always shattered by extraordinary economic events. But then, not all economic convulsions are alike. For example, the Oct. 19, 1987, stock market crash was the biggest one-day drop ever. The Standard & Poor’s Composite fell by 20.5 percent, the FTSE 100 by 12.2 percent and the Nikkei 225 by 14.9 percent the next day.

The crisis spread around the world, but there was no recession. Instead, world stock markets recovered, creating a colossal bubble that peaked 13 years later, in 2000.

In a survey that I conducted immediately after the 1987 crash, I found that the biggest concern expressed by individual and institutional investors in the US was essentially that the stock market had been overpriced. After the crash corrected that problem, many people apparently did not feel there was much more to worry about. The only parallel to the Great Depression was the stock market drop itself.

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