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. Market Psychology

    Market psychology is a term used to describe the sentiment financial ...
  2. John Maynard Keynes

    Keynes is regarded as one of the founding fathers of modern day ...
  3. Breeder's Insurance Policy

    Insurance coverage for the damage, theft or loss of bred animals. ...
  4. Trading Psychology

    Trading psychology refers to the emotions and mental state that ...
  5. Natural Capital

    A reference to the stock of natural resources, such as water ...
  6. Economics

    Economics is a social science concerned with the production, ...
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

    Spirit Releases Investor Update (SAVE)

    Spirit announced select revenue and expense figures for Q4, 2016 and 2017.
  4. Investing

    Spirit Airlines Markedly Ups Customer Satisfaction

    New airline performance metrics from the Department of Transportation are out, and in at least one key area, Spirit Airlines (NASDAQ: SAVE) is doing surprisingly well. Customer complaints per ...
  5. Insights

    Two Faces of Economy Collide: Data vs. Sentiment

    Soaring confidence about the economy contrasts with hard data showing weakness
  6. Investing

    Pixar Vs. Everyone Else: Who Is the Next Animation Star? (DIS, CMCSA)

    Find out who is quickly closing in on Disney and Pixar for the animated movie crown. What companies offer investors an opportunity in the crowded market.
  7. Trading

    Giants Of Finance: John Maynard Keynes

    This rock star of economics advocated government intervention at a time of free-market thinking.
  8. Investing

    Lift A Glass to the Whiskey ETF (WSKY)

    The world’s first whiskey ETF paves the way for individual spirits-based funds.
  9. 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?
  10. Insights

    Seven Decades Later: John Maynard Keynes' Most Influential Quotes

    It's been 72 years since the influential economist died; here are some of his most influential quotes.
  1. Why aren't economists rich?

    "If you're so smart, how come you're not rich?" is a question that economists seem to invite. If they can explain the intricacies ... Read Answer >>
  2. What causes a recession?

    A recession is a significant decline in economic activity lasting more than a few months, normally visible in real GDP, income ... Read Answer >>
  3. What is the relationship between human capital and economic growth?

    Learn what human capital and economic growth are, how human capital is related to economic growth and see examples of the ... Read Answer >>
  4. How do you calculate the marginal propensity to consume?

    Learn about the theoretical mathematical calculation for marginal propensity to consume (MPC), which is the crucial variable ... Read Answer >>
  5. Does the law of demand in economics describe real human behavior?

    Learn how the law of demand can be used to describe human nature, even if it cannot always produce accurate predictions about ... Read Answer >>
Hot Definitions
  1. Bond

    A bond is a fixed income investment in which an investor loans money to an entity (corporate or governmental) that borrows ...
  2. Compound Annual Growth Rate - CAGR

    The Compound Annual Growth Rate (CAGR) is the mean annual growth rate of an investment over a specified period of time longer ...
  3. Net Present Value - NPV

    Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows ...
  4. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  5. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
  6. Limit Order

    An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
Trading Center