Revision - Animal Spirits

Animal spirits refers to the expectations of businesses, entrepreneurs and consumers. When business confidence is high, we expect to see a rise in planned capital investment at each rate of interest. If there is a downturn in business confidence, for example during a recession, then planned investment may fall and some capital investment projects may be scrapped even when interest rates are fairly low.

The animal spirits of consumers are also hugely important notably for countries where consumer demand for goods and services is the engine of short term growth. Consumer sentiment is affected by factors such as actual and expected unemployment, changes in house prices and share values, changes in direct and indirect taxation and people’s perceptions about the general state of the economy and where it might be heading.

The term “animal spirits” was popularized by John Maynard Keynes in his 1936 book “The General Theory of Employment, Interest and Money,” is related to consumer or business confidence. According to economist Robert Shiller, it refers also to the sense of trust that people have in each other and this can be damaged by events such as the credit crunch and the subsequent financial crisis. Shiller argues that “When animal spirits are on ebb, consumers do not want to spend and businesses do not want to make capital expenditures or hire people.”

Changes in animal spirits can lead to shifts in one or more of the components of aggregate demand and have a powerful effect on short run output and income. But when animal spirits are poor, the traditional techniques of managing aggregate demand by using fiscal and monetary policy may become less effective.