Mon, Nov 17, 2008 - Page 9 News List

Reviving ‘animal spirits’ to raise confidence

By Robert Shiller  /  STAFF REPORTER

Moreover, many financial experts blamed the 1987 crash on a kind of programmed trading called “portfolio insurance,” which most thought would stop.

But recent events do not carry such a rosy interpretation. The stunning magnitude of recent declines cannot be dismissed as a one-day anomaly caused by a technical trading glitch.

The week of Oct. 3 to Oct. 10 was the worst stock market week in the US since the Great Depression, while Japan’s stock market performed worse than it did in the worst week of the Asian financial crisis ten years ago.

Similarly, Mexico’s stock market performed about as badly as it did during the worst week of the Mexican financial crisis in 1995, and Argentina’s stock market roughly matched the worst weekly drop during the country’s financial crisis of 1997 to 2002. Extraordinary stock market volatility, both up and down, has continued since.

The current stimulus and bailout plans were hatched in reaction to that dreadful week. The G7 countries announced a coordinated plan to fix the world economy on Oct. 10, and that weekend the G20 countries endorsed the plan.

But stock markets were barely higher in early this month. In China and India, they were lower.

The erosion of animal spirits feeds on itself. Immense market volatility serves only to reinforce people’s sense that something is really wrong. A volatility feedback loop begins: the more volatility, the more people feel they must pay attention to the market, and hence the more erratic their trades.

Perhaps the saving grace in this situation is that animal spirits can and sometimes do change direction. Confidence is a psychological phenomenon, and can make seemingly capricious jumps up as well as down.

The most promising prospect for a return of business confidence now would be some kind of public inspiration. In the US, president-elect Barack Obama seems to have the charisma to create this, and his status as the first minority president marks a major historical transition that might have great positive psychological impact in the US and around the world.

Whatever the near future holds the multitude of plans now being discussed to deal with this global crisis need to be judged with attention to the elusive and inexplicable effects they might have on confidence. The “animal spirits” that Keynes identified generations ago remain with us today.

Robert Shiller is professor of economics at Yale University and chief economist at MacroMarkets LLC.


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