Irrational Exuberance and Animal Spirits

The phrases ‘irrational exuberance’ and ‘animal spirits’ have been used to incorporate a wider understanding of human psychology in economic theory. There is, however, a fundamental inconsistency in retaining the rational dynamic of the neoclassical model while modifying it to accommodate human psychology. Discarding basic assumptions of the model invalidates the model. Robert Shiller seeks to establish firm psychological ‘anchorages,’ citing research suggesting the influence of ‘social pressures.’ Social pressures are readily understood in terms of the giving and receiving of support. George Akerlof and Shiller cite ‘money illusion’ as the cause of the Great Depression. They argue that falling prices raised real wages, and the appropriate response would have been reductions in nominal wages. In money-bargaining, the whole dynamic of economic transactions centres on money. Money and money-bargaining systems are no illusion. Rather, it is the neoclassical model that is the illusion. The erosion of purchasing power is a disadvantage of bargaining counters, but does not detract from the observable realism of money as a bargaining counter used in money-bargaining systems. The appropriate response to falling prices in the Great Depression was the rebuilding of money-bargaining chains. Much depends on the adopted frame of reference. The idea of ‘stories,’ ‘narratives’ and ‘anecdotes’ is contrasted with the idea of frames of reference.