What is 'Animal Spirits'?

Animal Spirits is a term used by the famous British economist, John Maynard Keynes, to explain financial and buying decisions in conditions of uncertainty. In Keynes’ 1936 publication, The General Theory of Employment, Interest and Money, animal spirits describes the human emotion that drives consumer confidence. In modern economic terms, animal spirits describes the psychological factors that drive investors to take action when faced with high volatility in the capital markets. The term is derived from the Latin spiritus animalis which means the breath that awakens the human mind.

BREAKING DOWN 'Animal Spirits'

The technical concept of animal spirits, or spiritus animalis, can be traced as far back as 300 BC when the term was used in the fields of human anatomy and medicine physiology. The term referred to the fluid or spirit present in sensory activities and nerves in the brain. Animal spirits was also used in literary culture and referred to states of physical courage, gaiety and exuberance. The literary meaning implies that animal spirits can be high or low depending on the level of health and energy of the individual. The modern version of the term is used in finance to describe investor psychology and confidence.

Adam Smith, another famous British economist, believed that if people pursued their own economic self-interests in a free market economy, there would be no need for government intervention, John Maynard Keynes understood that people might be irrationally guided in pursuing their economic self-interests. In his book, The General Theory of Employment, Interest and Money, Keynes explained that trying to estimate the yield of various industries, companies or activities using general knowledge and available insight would realize little to nothing. Therefore, the only way people can make decisions in such an uncertain environment is if they are guided by animal spirits.

The Role of Animal Spirits in Financial Markets

Animal spirits represent the confidence, fear and pessimism that impact the decisions that fuel or hamper economic growth. The 2008 financial crisis revived interest in the role that animal spirits play in the financial markets. If spirits are low, then confidence levels will be low, which will drive a promising market down even though the fundamentals of the market or economy remain strong. Likewise, if spirits are high, confidence will be high among participants in the economy and market prices will soar. For example, the 2008 market was rife with financial innovation, which was initially assumed to a positive outcome until the financial instruments were found to be deceptive and fraudulent. At this point, investor confidence plummeted, a sell-off ensued, and the markets plunged.

According to the theory behind animal spirits, the decisions of business leaders are based on intuition and the behavior of competitors rather than analysis. Intuition in behavioral economics follows the laws of social psychology, which affect the capital markets.

After President Donald Trump won the presidential election in November 2016, the markets were bullish indicating a return of animal spirits. Trump’s plans to cut tax and increase spending fueled consumer and business confidence although there was no way to be sure that the proposals would come to fruition. Animal spirits is a component of economics and one that helps to explain why individuals and firms sometimes make poor investment decisions.

  1. Animal Mortality Insurance

    Financial protection for businesses in which animals play a valuable ...
  2. Feed Ratio

    The relationship between the price for which a unit of livestock ...
  3. Keynesian Economics

    Keynesian economics is an economic theory of total spending in ...
  4. Push On A String

    When monetary policy cannot entice consumers into spending more ...
  5. Deficit Spending

    When a government's expenditures exceed its revenues, causing ...
  6. Drought Sale

    When a farmer is forced to sell more animals than in a typical ...
Related Articles
  1. Insights

    Will 'Animal Spirits' Fire Up the U.S. Economy?

    Despite bullish sentiments, economists forecast less than spirited GDP growth ahead
  2. Insights

    Spirit Releases 2016 Traffic Results (SAVE)

    Shares in Spirit are up 50 percent since January 2015. On Jan. 10, the airline released its December and its 2016 operational results.
  3. Insights

    What Causes Bubbles?

    A look at how asset bubbles are formed according to different schools of thought.
  4. Investing

    Lift A Glass to the Whiskey ETF (WSKY)

    The world’s first whiskey ETF paves the way for individual spirits-based funds.
  5. Insights

    Pump Primer: Trump's Pump Blunder Explained

    Trump raises a lot of questions about his tax reform (and know-how) with a reference to Keynes. Isn't this supposed to be a supply-side thing?
  6. Insights

    Seven Decades Later: John Maynard Keynes' Most Influential Quotes

    It's been 71 years since the influential economist died, here are some of his most influential quotes.
  7. Investing

    Sipping The Good Stuff

    Scotch Whisky is one of the fastest growing products in the liquor business. Learn which companies are cashing in.
  8. Investing

    Explaining the Liquidity Preference Theory

    According to the liquidity preference theory, investors demand interest in return for sacrificing their liquidity.
  1. How did John Maynard Keynes influence business cycle theory?

    Read about the impact of John Maynard Keynes on business cycle theory and the development of macroeconomics to study aggregate ... Read Answer >>
  2. What is demand-side economics?

    Learn the basic theory of demand-side economics, which emphasizes the importance of aggregate demand and supports government ... Read Answer >>
  3. How does behavioral economics treat risk aversion?

    Learn about the relationship between decision-making and risk, as described by one of the foundational theories in behavioral ... Read Answer >>
  4. How Can Inflation Be Good for the Economy?

    Find out why some economists and public policy makers believe that inflation is a good, or even necessary, phenomenon to ... Read Answer >>
  5. What are "booms" and "busts" in the business cycle?

    Find out what "boom" and "bust" mean in the business cycle. Read about a few different theories among economists about what ... Read Answer >>
Hot Definitions
  1. Standard Deviation

    A measure of the dispersion of a set of data from its mean, calculated as the square root of the variance. The more spread ...
  2. Entrepreneur

    An entrepreneur is an individual who founds and runs a small business and assumes all the risk and reward of the venture.
  3. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  4. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  5. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  6. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
Trading Center