Keynes used the expression “animal spirits” but three times in the whole General Theory, and all towards the end of Chapter 12, yet the concept seems to cause a considerable amount of confusion.
The relevant passage where the expression occurs is here:
“Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than on a mathematical expectation, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits—of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die;—though fears of loss may have a basis no more reasonable than hopes of profit had before.The term “animal spirits” was borrowed by Keynes from Descartes (Gerrard 1994: 15), and it is obvious that Keynes did not seriously use it in the original sense of Descartes, to mean “the fiery particles of the blood distilled by the heat of the heart” (as quoted in Gerrard 1994: 15). Critics of Keynes complain that they don’t understand what he means by it. But unless such people are incapable of reading English, the definition is perfectly clear: Keynes uses “animal spirits” in the sense of “a spontaneous [human] urge to action rather than inaction.”
It is safe to say that enterprise which depends on hopes stretching into the future benefits the community as a whole. But individual initiative will only be adequate when reasonable calculation is supplemented and supported by animal spirits, so that the thought of ultimate loss which often overtakes pioneers, as experience undoubtedly tells us and them, is put aside as a healthy man puts aside the expectation of death. (Keynes 2008 : 144).
Now Austrians like Jerry O’Driscoll also complain about the use of the term, and also that Keynes’s “psychology was of the crudest” kind. The answer to all these complaints about the use of the phrase is rather obvious to me: all talk, and use, of the phrase and concept of “animal spirits” can be dropped entirely from Post Keynesian treatments of subjective expectations without any problem at all. Modern Post Keynesian subjective expectations theory has, anyway, developed itself by using ideas from contemporary psychology, and, even if Keynes’s psychology was crude, this is also irrelevant to the modern theory.
The concept of “animal spirits” as used by Keynes is not even necessary to the modern subjective expectations theory. So much of the discussion of Keynesian subjective expectations by Austrians descends into waving the concept of “animal spirits” around and complaining about it, when this is nothing but the red herring fallacy, the logical fallacy in which some irrelevant topic is invoked in order to divert attention from the original issue. What is more ridiculous is that most Austrians also adhere to the view that expectations are subjective.
Whether or not humans have a “spontaneous urge to action rather than inaction” is a matter for modern psychology, evolutionary psychology, neuroscience and cognitive science.
All that Keynes needed to say is that human beings can, and do, act in the face of uncertainty, whether that is real or perceived uncertainty. This statement that would be a synthetic proposition, whose truth can only be known a posteriori (i.e., by empirical evidence). Because of uncertainty about the future, expectations in the investment decision are not a matter of mathematical calculation.
In A Treatise on Probability (1921), Keynes had already dealt with the issue of probability, and had argued that under uncertainty the likelihood of future events came in different forms:
(1) that there are no probabilities at all (fundamental uncertainty),By 1937, Keynes had come to stress the importance of uncertainty in the sense of (1) above in economic decision making:
(2) that there may be some partial ordering of probable events but no cardinal numbers can be placed on them,
(3) that there may be numbers but they cannot be discovered for some reason, and
(4) that there may be numbers but they are difficult to discover (Barkley Rosser 2001: 559).
“By ‘uncertain’ knowledge, let me explain, I do not mean merely to distinguish what is known for certain from what is only probable. The game of roulette is not subject, in this sense, to uncertainty; nor is the prospect of a Victory bond being drawn. Or, again, the expectation of life is only slightly uncertain. Even the weather is only moderately uncertain. The sense in which I am using the term is that in which the prospect of a European war is uncertain, or the price of copper and the rate of interest twenty years hence, or the obsolescence of a new invention, or the position of private wealthowners in the social system in 1970. About these matters there is no scientific basis on which to form any calculable probability whatever” (Keynes 1937: 213–214).Expectations are subjective, and the investment decision is not rational (the word “rational” is here used in the sense of the neoclassical rational expectations hypothesis). Business people making investments are also influenced by what other business people and doing, and there can be general waves of optimism or pessimism. Keynes’ ideas on uncertainty and the consequences for expectations were taken up by G. L. S. Shackle (1952, 1955, 1969) and Post Keynesians (Dow and Hillard 1995; King 2002: 181-188; Dunn 2008: 69-116), and developed into the modern subjective expectations theory.
In essence, in conditions where a human makes a decision in the face of genuine uncertainty, he or she can (1) recognise that uncertainty or (2) fall into the trap of thinking they do not face uncertainty, perhaps by believing that they can provide objective probabilities for future outcomes. Either way most people have a propensity to act.
So what happens in the case of investment? People making investment decisions cannot know the future or give objective probabilities for many possible events affecting their decisions: uncertainty simply cannot be quantified. Their subjective expectations in the short or long run about the profitability and success of their investment influence the decision, and they are also influenced by what other people around them think.
Even a cursory reading of the specialist literature in modern cognitive and evolutionary psychology suggests to me that the Post Keynesians would have little difficulty in using modern theories to support their view of subjective expectations in the investment decision.
“Human beings make a vast numbers of decisions throughout their lives. Some of these have rather trivial consequences ... others have more far reaching repercussions ... In the 1970s Amos Tversky and Nobel Laureate Daniel Kahneman published some startling work suggesting that people are rather poor at making decisions in situations that involve some degree of uncertainty. In particular, Tversky and Kahneman proposed that much of our reasoning under uncertainty involves the use of heuristics. Heuristics are short-cut solutions to a problem, which are usually fast and easy to apply but which do not guarantee a correct solution” (Workman and Reader 2004: 230).The “heuristic and biases” method of Tversky and Kahneman (1974; and Kahneman et al. 1982) described above appears to be a very useful approach which confirms and complements the Post Keynesian theory of business decision-making under uncertainty (Fontana 2009: 39–41). Keynes can be seen as having examined the heuristics and biases by which people in business make decisions about investment, with their use of instincts, conventions and habits of mind. But heuristics do not necessarily “guarantee a correct solution.” A decision not to invest might be wrong, just as a decision to invest can be in error. The cognitive bias in decision-making called the bandwagon effect is relevant to how investors and business people are caught up in the general state of expectations, how waves of optimism can cause more and more businesses to make investment decisions, or how financial markets are subject to rapid changes from bear to bull positions and vice versa.
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