Savvy Nickel
by George A. Akerlof & Robert J. Shiller
Two Nobel Prize winners explain how the psychological forces Keynes called 'animal spirits' drive economic fluctuations. Essential for understanding why markets and economies behave so irrationally — and what investors can do about it.
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John Maynard Keynes introduced the term "animal spirits" in 1936 to describe the spontaneous urge to action that drives economic activity beyond what cold calculation would justify. George Akerlof (2001 Nobel Prize in Economics) and Robert Shiller (2013 Nobel Prize) revive and systematize this concept, arguing that five psychological forces — confidence, fairness, corruption, money illusion, and stories — explain the economic fluctuations that standard macroeconomic models cannot. Published in 2009 as the Great Recession unfolded, the book directly challenged the efficient market consensus that had failed to predict the crisis.
| Attribute | Details |
|---|---|
| Title | Animal Spirits |
| Authors | George A. Akerlof & Robert J. Shiller |
| Publisher | Princeton University Press |
| Published | 2009 |
| Pages | 264 |
| Reading Level | Intermediate |
| Amazon Rating | 4.3/5 stars |
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George Akerlof is University Professor at Georgetown University and won the 2001 Nobel Prize in Economics (with Michael Spence and Joseph Stiglitz) for his analysis of markets with asymmetric information. His 1970 paper "The Market for Lemons" is one of the most cited in economics — it demonstrated how information asymmetry destroys markets.
Robert Shiller is Sterling Professor of Economics at Yale and won the 2013 Nobel Prize in Economics (with Eugene Fama and Lars Peter Hansen) for empirical analysis of asset prices. He developed the CAPE ratio and predicted both the dot-com crash and housing bubble.
Keynes's original observation: economic activity is driven partly by rational calculation and partly by the spontaneous confidence that things will work out. When confidence collapses, rational calculation says "stay put" regardless of economic fundamentals.
The confidence multiplier:
Economic activity → Income → Spending → More economic activityWhen confidence supports this cycle, it becomes self-reinforcing upward. When confidence collapses, the cycle reverses:
Job losses → Fear → Reduced spending → More job lossesRational models cannot fully capture this feedback because confidence is not directly observable or predictable. It responds to narratives, social proof, and emotional contagion — forces outside standard macroeconomic models.
Investment application: Market confidence follows the same feedback dynamics. Bull markets become self-reinforcing as rising prices attract more investors, whose buying raises prices further. Bear markets become self-reinforcing as falling prices cause selling, which drives prices lower. Understanding this cycle does not allow prediction of turning points but does contextualize extreme market behavior.
The consumer confidence survey as leading indicator:
| Consumer Confidence Index Level | Subsequent 12-Month S&P 500 Return (historical average) |
|---|---|
| Above 130 (high confidence) | +4% |
| 100-130 (moderate) | +8% |
| 70-100 (below average) | +12% |
| Below 70 (low confidence) | +18% |
Counterintuitively, low confidence periods have historically preceded higher stock returns. This is consistent with the contrarian investing principle: the best time to buy is when fear is highest.
Akerlof and Shiller argue that fairness norms — deeply embedded in human psychology — shape economic behavior in ways rational models miss.
Fairness in labor markets:
Standard economic models predict that wages should fall during recessions as labor supply exceeds demand. In practice, companies rarely cut wages below what workers perceive as fair, even during severe downturns. Instead they lay off some workers and keep the rest at existing wages.
Why:
| Wage Cut (economically rational) | Layoffs (economically suboptimal) |
|---|---|
| Efficient: maintains employment | Inefficient: destroys specific human capital |
| Violates fairness norm | Perceived as necessary, not unfair |
| Damages morale of remaining workers | Remaining workers feel fortunate |
| May trigger strikes or resignation | Remaining workers maintain productivity |
The fairness norm is not irrational — it reflects genuine social coordination mechanisms. But it causes labor markets to clear through quantity (employment) rather than price (wages), amplifying recessions.
Investment application: Companies that violate perceived fairness norms with customers, suppliers, or employees face reputational and regulatory backlash that standard financial models do not capture. Identifying businesses with strong fairness reputations (versus those extracting maximum value from every transaction) provides useful qualitative information about long-term franchise durability.
Akerlof and Shiller document how corruption and opportunism expand during boom periods and contract during busts:
| Phase | Corruption Level | Mechanism |
|---|---|---|
| Early boom | Low | High standards maintained |
| Mid-boom | Rising | Easy profits reduce scrutiny |
| Late boom | Peak | Fraud widespread; hard to avoid |
| Bust | Declining | Fraud exposed; enforcement increases |
| Recovery | Low | Clean-up underway |
This cyclical pattern of fraud and clean-up has appeared consistently throughout financial history: the 1920s bull market (exposed by 1930s fraud prosecutions), the savings and loan crisis (fraud widespread, prosecuted in early 1990s), Enron-era fraud (exposed 2001-2002), and mortgage fraud of the 2000s (exposed 2008-2010).
The investment implication: Late-cycle bull markets carry elevated fraud risk. The time of maximum return is also the time of maximum fraud exposure. Diversification and skepticism of complex structures provide protection.
Humans confuse nominal and real values. They think in current dollars rather than inflation-adjusted terms, leading to systematic misjudgments.
Money illusion in wages:
A 5% pay cut in a 0% inflation environment feels like a severe pay cut. A 2% pay increase in a 7% inflation environment (a 5% real pay cut) feels like a raise. Workers respond more negatively to nominal wage cuts than to equivalent real wage cuts through inflation.
Money illusion in investing:
| Nominal Return | Inflation Rate | Real Return | Investor Perception |
|---|---|---|---|
| 10% | 8% | 2% | "Great year!" |
| 2% | 0% | 2% | "Mediocre year" |
| -5% | -10% | +5% | "Terrible year!" |
The investor who earns 10% during 8% inflation earned exactly the same real return as the investor who earned 2% during 0% inflation — but feels dramatically differently about it.
Mortgage money illusion: Homeowners focus on nominal home price appreciation without adjusting for inflation. A house that doubled in nominal value over 20 years during 3.5% average inflation gained only 29% in real value — a 1.3% annual real return, below the long-run stock market.
Akerlof and Shiller's most original contribution is the argument that narratives — stories about how the economy works — drive economic behavior as much as fundamentals.
The housing bubble narrative (2001-2006):
The dominant story: "Real estate always goes up. Get in now or be priced out forever. Your home is your best investment."
This narrative spread through family conversations, media coverage, and real estate advertising. It changed behavior: people bought homes they could not afford on the assumption prices would always provide an exit. The narrative was self-fulfilling while it held — prices rising validated the story, which attracted more buyers, which raised prices further.
When the story changed (2006-2007):
"Housing prices are falling in Phoenix. Foreclosures are rising. Maybe prices don't always go up."
The new narrative spread equally virally. Buyers stepped back. Prices fell. More stories of falling prices spread. Sellers panicked. The self-reinforcing cycle reversed.
Shiller's narrative economics:
Shiller has developed this concept most fully in his subsequent book Narrative Economics (2019). He argues that the virality of economic narratives — how easily they spread, how memorable they are — influences economic outcomes more than most economists acknowledge.
For investors: Identify the dominant narrative surrounding any asset or market. Narratives can be partially true and still drive prices far beyond fundamental values. The dot-com narrative ("the internet changes everything") was correct about the long-term importance of the internet and wrong about valuations in 1999. The skill is separating the valid insight in the narrative from the price implications that may already be (or be incorrectly) baked in.
Akerlof and Shiller apply their five animal spirits to explain eight persistent economic puzzles:
Because confidence collapses, fairness norms prevent wage adjustments, and the feedback loop between consumption and employment becomes self-reinforcing downward. Standard monetary policy may be insufficient if the confidence collapse is severe enough (the "liquidity trap" Keynes described).
Through their influence on confidence and narratives, not just through the mechanical interest rate transmission channel. Federal Reserve communication about future policy affects behavior through story as much as through actual rate changes.
Because wages are sticky downward (fairness norms prevent cuts to clearing levels) and because employers prefer to maintain morale by keeping wages steady and laying off some workers rather than cutting wages for all.
Because money illusion means workers accept real wage cuts more readily when they come through inflation than through nominal cuts. Moderate inflation "lubricates" the adjustment mechanism in ways that zero inflation cannot.
Because saving decisions respond to narratives and confidence as much as to calculated future needs. Bull markets encourage spending (confidence in future wealth); bear markets encourage saving (fear of insufficient future resources).
Because they are driven by narratives and confidence that shift faster than underlying fundamentals. The rational model predicts that asset prices should only change when fundamentals change; in reality they change continuously with narrative shifts.
Because real estate is uniquely susceptible to narrative epidemics: it is local (every market has its own story), emotional (homes are identity-laden), visible (everyone sees prices in their neighborhood), and leveraged (small equity magnifies gains and losses).
Because confidence in opportunities, fairness of institutions, and prevalent narratives about opportunity and discrimination shape economic behavior in ways that interact with structural barriers. This is the most politically charged chapter in the book.
The narrative premium: When a compelling story (AI revolution, clean energy transition, cryptocurrency disruption) drives asset prices, valuations often exceed what fundamentals justify. The narrative is not necessarily wrong. The price implication may be wrong.
Signs of narrative-driven excess:
Signs of narrative-driven undervaluation:
Animal spirits provides a framework for calibrating how much confidence is priced into various asset classes:
| Market Environment | Confidence Level | Implication |
|---|---|---|
| Low VIX, narrow credit spreads, high CAPE | High confidence priced in | Future returns likely to disappoint |
| High VIX, wide spreads, low CAPE | Low confidence | Future returns likely to be above average |
| Rapidly rising VIX, credit stress | Confidence collapsing | High uncertainty; potential opportunity if financially secure |
Q: Is this book about macroeconomics or investing?
A: Both. The macro framework (confidence cycles, narrative epidemics, money illusion) directly informs long-run asset allocation and return expectations. It is most valuable for investors trying to understand the environment they are operating in.
Q: How does this complement Irrational Exuberance?
A: Irrational Exuberance focuses specifically on stock and housing market valuations. Animal Spirits provides the broader macroeconomic framework (labor markets, recessions, policy) that explains why excessive valuations develop and how they affect the real economy.
Rating: 4.4/5
Animal Spirits is the most intellectually ambitious book on behavioral macroeconomics written for general readers. Its five-factor framework, narrative economics preview, and confidence cycle analysis provide a richer understanding of market behavior than any purely quantitative model. Essential context for long-term investors trying to understand the macroeconomic environment.
Paperback: Buy on Amazon
Kindle: Buy on Amazon
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