The following articles look at a recently published book by George Akerlof of the University of California, Berkeley, and Robert Shiller of Yale. They examine the role of what Keynes called ‘animal spirits’ and is the title of the book.
The motivation to make economic decisions (to buy, to sell, to invest, etc) may not be ‘rational’ in the sense of carefully weighing up marginal costs and marginal benefits. Rather it can be one of over-optimism in good times or over-pessimism in bad times. Just as individuals have ‘mood swings’, so there can be collective mood swings too. After all, confidence, or lack of it, is contagious. This motivation that drives people to action is what is meant by animal spirits.
But are animal spirits a blessing to be nurtured or a curse to be reined in? Should governments seek to constrain them?
An economic bestiary The Economist (26/3/09)
Good Government and Animal Spirits Wall Street Journal (23/4/09)
Irrational Exuberance New York Times (17/4/09)
Animal Spirits: A Q&A With George Akerlof Freakonomics: New York Times blog (30/4/09)
Questions
- Describe what is meant by ‘animal spirits’ and their effects on human behaviour.
- Why may animal spirits make economies less stable?
- How may animal spirits help to explain exchange rate overshooting?
- Discuss whether governments should seek to constrain animal spirits and make people more ‘rational’? Also consider what methods governments could/should use to do this?
One of the industries always hard hit by any economic downturn is the building and construction industry. The three articles below look at different aspects of the construction downturn. The building industry in Spain (article 1) has been particularly hard hit, perhaps because of the previous scale of the boom. When there is a recession, different industries are always hit in different ways, depending on the nature of the demand they face. Construction and building can be very badly affected as much of the expenditure on them is ‘investment’ expenditure and this will often be delayed in times of economic downturn.
Building boom reduced to ruins by collapse of Spain’s economic miracle Guardian (19/1/09)
Housing starts lowest since 1924 as construction bears brunt of recession Guardian (15/12/08)
UK construction activity slumps to record low Times Online (5/1/09)
Questions
- Write a short paragraph explaining the current state of the construction industry in the UK.
- Explain the accelerator theory.
- Discuss the extent to which the accelerator theory might help to explain the current state of the construction industry in the UK and Spain.
Inflationary expectations can be an important determinant of the actual level of inflation and so the Bank of England monitor people’s perceptions of inflation closely. Expectations of inflation are currently at their highest level in eight years.
Questions
| 1. |
Explain the transmission mechanism by which higher inflationary expectations are translated into inflation. |
| 2. |
What are the key determinants of inflationary expectations? |
| 3. |
Discuss strategies that (a) the Bank of England and (b) the government can adopt to reduce inflationary expectations. |
As part of its Target 2.0 competition for students, The Times published a series of briefings looking at the factors that cause inflation. The one linked below considers the role of labour markets in determining inflation.
Interplay of work and inflation rate Times Online (2/2/07)
Questions
| 1. |
Explain the key determinants of the equilibrium level of wages in the labour market. |
| 2. |
Assess the role of equilibrium labour market wages in the determination of the level of inflation. |
| 3. |
Discuss the extent to which the NAIRU is still a relevant theory when considering the determinants of inflation. |