Animal Spirits and the Economy George A. Akerlof ISEO June 23, 2010

1. Animal Spirits andthe EconomyGeorge A. Akerlof ISEOJune 23, 2010

2. Introduction • Robert Shiller. • Brief history of economic thought. • Watered down General Theory. • Vulnerable to attack.

3. Full employment. • Macroeconomics: deviations from full employment. • Frictions.

4. Animal Spirits • Confidence. • Fairness. • Corruption. • Money Illusion. • Stories.

5. Confidence • Not just a prediction. • Also involves Trust.

6. Fairness • Important in wage and price determination.

7. Snake Oil • Capitalism does not: • Just produce what people want: (as long as firms make profits).

8. Snake Oil (continued) • Capitalism produces what people think they want: (as long as firms make profits).

9. Money Illusion • Important determinant of working of the economy.

10. Stories • Business cycles and stories. • Dot.com Bubble.

11. Summary • Confidence. • Fairness. • Snake Oil. • Money Illusion. • Stories.

12. Why Do Economies Fall into Recessions? • Cycles in psychology. • Current crisis: • Confidence, Snake Oil, and Stories.

13. What are the powers of central banks? • Limitations of open market operations. • Discount window.

14. Four Lines of Defense: • Regulation. • Rediscounting. • Deposit Guarantees. • Bankruptcy Management . • Shadow Banking: • No lines of Defense.

15. Current Crisis • Credit crunch. • Humpty Dumpty. • Target for full employment level of demand. • Target for full employment level of credit.

16. Meeting the Credit Target • Fed Lending Facilities. • Direct capitalization of banks. • Direct granting of credit by SGE’s.

17. Why Do We Need Such Targets? • Needed for planning. • Cost of lower unemployment: • From Bailout. • From Fiscal Stimulus.

18. Playpen Problem: • Need for Financial Regulation.