What are animal spirits and what is their relevance to perfo

What are “animal spirits” and what is their relevance to performance of the macroeconomy?

Solution

Animal Spirits is a term coined by Keynes. He used this word to describe human instincts that help shape consumer behavior. That is, it refers to the driving force behind consumer decisions regarding buying a product.

Even though it\'s a qualitative variable determining economic performance, it\'s an extremely important one. The most forceful application of animal spirits is herd behavior where, consumers get heavily influenced by actions and purchase decisions taken by previous consumers. As time progresses, strength of the herd behavior intensifies.

Similarly, investor sentiment is another example. It can build or ruin an economy. For example, mass loss of confidence on an economy can result in collective withdrawal of foreign investment, resulting in capital flight. Such mass capital flight can make an economy collapse, as has been evident from South-East Asian currency crises of 1997-98. On the other hand, a positive herd behavior can result in massive confidence on the economy, resulting in huge inflow of foreign investment resulting in fast economic growth.