Keynes was wrong; animal spirits do not drive growth

Here is Neil Irwin:

After Donald J. Trump won the presidential election, Americans’ optimism about the economic future soared. But midway through the year, that optimism has not translated into concrete economic gains.

This seeming contradiction exposes a reality about the role of psychology in economics — or more specifically, how psychology is connected only loosely to actual growth. It will take more than feelings to fix the sluggishness that has been evident in the United States and other major economies for years. Confidence isn’t some magic elixir for the economy: Businesses will hire and invest only when they see concrete evidence of demand for their products, and consumers intensify their spending only when their incomes justify it.

Long run growth is driven by fundamentals: free markets, property rights, sensible taxes, low corruption, human capital, technology, peace, etc. Short run growth is driven by aggregate demand, i.e. monetary policy.

That’s why I prefer monetarism to Keynesianism, despite all its faults.  At least monetarists understand that monetary policy drives AD.

PS.  Off topic, I found this NYT story to be of interest:

Jason Kenney, then a Conservative member of Parliament, convinced Prime Minister Stephen Harper that the party should court immigrants, who — thanks to Mr. Trudeau’s efforts — had long backed the Liberal Party.

“I said the only way we’d ever build a governing coalition was with the support of new Canadians, given changing demography,” Mr. Kenney said.

He succeeded. In the 2011 and 2015 elections, the Conservatives won a higher share of the vote among immigrants than it did among native-born citizens.

The result is a broad political consensus around immigrants’ place in Canada’s national identity.

That creates a virtuous cycle. All parties rely on and compete for minority voters, so none has an incentive to cater to anti-immigrant backlash. That, in turn, keeps anti-immigrant sentiment from becoming a point of political conflict, which makes it less important to voters.

In Britain, among white voters who say they want less immigration, about 40 percent also say that limiting immigration is the most important issue to them. In the United States, that figure is about 20 percent. In Canada, according to a 2011 study, it was only 0.34 percent.




38 Responses to “Keynes was wrong; animal spirits do not drive growth”

  1. Gravatar of marcus nunes marcus nunes
    4. July 2017 at 08:46

    Just as the Fed wonders where inflation is hiding!

  2. Gravatar of morgan s warstler morgan s warstler
    4. July 2017 at 08:53

    So silly.

    Low taxes and Dereg WORK. Markets are efficient.

    LIKE CONSUMERS, Yellen is more confident in raising rates bc of Trump Economy. If we had Hillary, there’d be no rate hike PERIOD.

    It’s very hard to see how both stories: Keynes on Animal Spirits and Monetary don’t both make sense.

    Scott, you seem to still in grips of TDS.


    Let e help… you’d HAPPILY take twice as many immigrants to US, but Trump Voters™ get to decide which ones they are. Bc utility.

    So SAY that, you’ll stop whining about Trump if he can fix H1B and increase overall immigrant flows.

  3. Gravatar of Steve F Steve F
    4. July 2017 at 09:21

    Agree with Morgan. We saw immediately how much better the economy is under Trump by way of the Fed responding with great bullishness on rate hikes.

  4. Gravatar of ssumner ssumner
    4. July 2017 at 10:07

    Steve, Rates are not “the economy.” The economy is the same as under Obama. When does Trump plan on making America great again?

  5. Gravatar of Oups Oups
    4. July 2017 at 10:25

    Monetary policy drives AD in our current policy regime. Keynes was justifying the necessity of stabilization policies. With a k-rule as advocated by Friedman, AD can be driven by sunspots.

  6. Gravatar of Steve F Steve F
    4. July 2017 at 10:36

    Does the Fed not change the rate based on views regarding the state of the economy?

  7. Gravatar of morgan s warstler morgan s warstler
    4. July 2017 at 11:10


    They get Trump = dereg and lower taxes. CEOs are out having a blast.

    Tiny example. Buddy owns coal mine in Ohio. Trump admin has been instantly approving dredging of ports. It took him no time to get train car system outfitted and pick up deal to take Erie dredge and ship it to old mines and refill.

    Scott, what you don’t know and I do is that Obama admin cut deal with SV in 2008.

    They would stop the Libertarian stuff, embrace comprehensive reform and embrace SJW JUNK, and be the ONLY sector not regulated anew.


    It’s not possible for you to pretend just letting things happen without Govt getting in way isn’t TRUMP.

    Get over yourself man, you aren’t that smart.

  8. Gravatar of Britonomist Britonomist
    4. July 2017 at 11:23

    “Long run growth is driven by fundamentals”

    Almost all self described Keynesians I’ve encountered agrees with this, that is *not* a monetarist take.

  9. Gravatar of Market Fiscalist Market Fiscalist
    4. July 2017 at 14:22

    On ‘Long run growth is driven by fundamentals: free markets, property rights, sensible taxes, low corruption, human capital, technology, peace, etc. Short run growth is driven by aggregate demand, i.e. monetary policy.’

    But isn’t short-term variations in aggregate demand largely caused by factors that could generally be classed as “animal spirits”?

  10. Gravatar of Benjamin Cole Benjamin Cole
    4. July 2017 at 15:40

    Great post, but what is definition of short and long run?

    Bad central banking can result in lost decades.

    Conversely Japan finance minister Takahashi Korekiyo sidestepped Great Depression through helicopter drops. If WWII had not intervened Korekiyo would have brought Japan ahead of the world by decades.

    The last 10 years in US are an example of light monetary asphyxiation.

  11. Gravatar of John John
    4. July 2017 at 16:21

    Happy 4th of july Mr. Sumners!

  12. Gravatar of Major.Freedom Major.Freedom
    4. July 2017 at 17:16

    “Long run growth is driven by fundamentals: free markets, property rights, sensible taxes, low corruption, human capital, technology, peace, etc. Short run growth is driven by aggregate demand, i.e. monetary policy.”

    No that’s not true either. You may not know this yet Sumner, but your economic worldview is fundamentally Keynesian, meaning, it is based on a belief concerning the causality of “demand”. It was Keynes who made monetarism a “thing” to begin with. To criticize Keynes’ economics, is to criticize monetarism indirectly.

    Even in the short run, growth is driven by production, not demand. Any seeming correlation between printing money and “growth” is only apparent to the extent that whatever toiler paper money is printed, it goes to the purchase of *already produced goods”. Printing money does not make goods appear out of thin air. No amount of money printing will “drive growth” in an economy without capital. All that money printing will do is “demand” non-existent goods that can’t be produced because of a lack of capital and property rights.

    You talk about growth being driven by property rights and free markets, but we don’t have respect for property rights nor a free market *in money production*.

    The only thing that printing money does is redistribute means of production and resources from wealth creating activities on net to wealth consuming activities on net. As part of this, it distorts economic calculation by making impossible any possibility of free market interest rates, relative spending, and relative prices.

    The correlation between declines in money and spending on the one hand, and declines in production and selling on the other, is co-extensive, meaning, one does not “cause” the other. They both decline because of a third causal phenomena. Yes, it is true that should spending suddenly collapse, that we would generally see a decline in production and selling. But it is also true that should production and selling suddenly collapse, we would generally see a decline in spending. Just because one declines along with the other, it doesn’t mean one causes the other. In the exact same way we can say that just because sudden production declines would generally be associated with spending declines, it doesn’t mean production causes spending, so too can we say that just because sudden spending declines would generally be associated with production declines, it doesn’t mean spending causes production.

    Not in the short run.

    Not in the long run.

    People do not cavalierly reduce their spending for no reason. It is not true that as long as spending is maintained, that there will be no “demand side problems”. The entire central banking system is one gigantic demand side problem. By its very existence, a free market in money is impossible, which makes demand a constant problem. It adversely affect relative spending. Inflation prevents free market relative pricing and relative interest rates. This puts constant stress on production.

  13. Gravatar of Major.Freedom Major.Freedom
    4. July 2017 at 17:21

    Yes yes, this theory of markets is “not useful” because you can’t get paid by a university to waste people’s money by doodling equations on paper trying to find the next miracle alchemy formula. But that doesn’t mean everyone is forced to pick a garbage theory for the sake of one’s career.

    Try reality, the truth. Get a job cutting grass if need be.

  14. Gravatar of Rajat Rajat
    4. July 2017 at 17:28

    Like Market Fiscalist said, can’t ‘animal spirits’ be used to refer to shifts in money demand – ie velocity – whether exogenous (due to a political shock or financial failure) or endogenous (due to a change in the stance of monetary policy)? For example, if Bernanke suddenly adopted NGDPLT following the Lehman failure, NGDP would probably have remained much more stable than it did. Would’t this have manifested as less money demand/higher velocity?

  15. Gravatar of ssumner ssumner
    4. July 2017 at 18:04

    Oups, Yup.

    Steve F. Yes, and your point?

    Morgan, You live in a fantasy world.

    Britonomist, I never said it was. I was discussing their differences on AD.

    Market Fiscalist, Apparently not.

    Rajat, I don’t see any reason to assume that shifts in money demand reflect “animal spirits”. More likely they reflect expectations of the future path of monetary policy, and/or supply shocks.

  16. Gravatar of Steve F Steve F
    4. July 2017 at 18:52

    Scott, that was what I was getting at, not some notion that rates = economy.

  17. Gravatar of Steve F Steve F
    4. July 2017 at 18:56

    Major Freedom, I am sympathetic to the ideas you present (believe me, I really am); however, an issue I see is that it appears to be true that production incentives change based on spending. What is your response to something like how unstable money can cause reduction in incentive to produce; thus money does have a real effect on production?

  18. Gravatar of H_WASSHOI H_WASSHOI
    5. July 2017 at 00:30

    (memorial comment)

  19. Gravatar of Benjamin Cole Benjamin Cole
    5. July 2017 at 02:06

    OT but fascinating:

    The Korean Kospi (stock market) is now up 20% YOY. It is up 0.33% today right after a missile test.

    in Washington they are making long, long faces about North Korea, and the US is steaming warships in circles. The media is on heightened alert.

    In Seoul, is it party time in Fat City. Property values busting new records.

  20. Gravatar of Lorenzo from Oz Lorenzo from Oz
    5. July 2017 at 04:34

    On migration, as the NYT article acknowledges, border control is central to the lack of traction for anti-immigrant sentiment. Bring in diverse range of people selected for ability to contribute as deliberate policy, and the electorate will be cool. The Australian experience also shows this.

    It is the sense of having no say which is deadly to keeping populism at bay.

  21. Gravatar of Benjamin Cole Benjamin Cole
    5. July 2017 at 05:01


    Explain why many Aussie banks will not extend home loans to foreigners.

  22. Gravatar of jj jj
    5. July 2017 at 07:50

    I’m gradually coming around to a greater respect of Keynes’ ideas. He wrote about animal spirits coming off of a long period where monetary policy was fixed by the gold standard; monetary policy was the first mover, not last mover as it is today.

    Even now, monetary policy isn’t entirely the last mover in the USA because many FOMC voters have precommitted to certain policies or paths, leaving room for animal spirits to drive demand. Yes under law it should be the last mover to achieve its dual mandate, but the markets know that the fed is sometimes derelict in its duty.

    Of course this all hinges on how you define animal spirits, and Keynes specifically meant that these are raw emotions and not “the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities”. Here I disagree with Keynes because I think that raw emotions have little impact on markets, and the businessman’s quantitative analysis has adequate explanatory power for how the businessman’s rational expectations seem to drive markets, rather than monetary policy.

    I just thought of the perfect term for this – “sticky monetary policy”. In fact it’s so good, it’s probably been said before.

  23. Gravatar of Viking Viking
    5. July 2017 at 08:31

    @Ben Cole

    I think the key is foreign income as opposed to being foreign.

    Why don’t you emigrate, get a job in a different country, and try to get a US mortgage based on foreign pay stubs?

  24. Gravatar of Antischiff Antischiff
    5. July 2017 at 08:43

    Dr. Sumner

    “Animal spirits” always struck me as an embarrassing phrase to use. It makes sense that I don’t think it ever appeared in an academic paper before appearing in a book, because it’s still never been formally operationlized, correct?

  25. Gravatar of ssumner ssumner
    5. July 2017 at 12:25

    Steve, Not sure what you are asking.

    JJ, Yes, it makes more sense under a gold standard.

  26. Gravatar of Christian List Christian List
    5. July 2017 at 14:36

    Canada has “the luxury of being surrounded by oceans on three sides, and then by the U.S. border.”

    The NYT being honest for once. Tellingly only when quoting someone else.

  27. Gravatar of Benjamin Cole Benjamin Cole
    5. July 2017 at 15:53

    Viking–oh please. Aussie major banks not extending loans on foreign income when they would happily before? My guess is that loans to foreigners have lower default rates.

    Australia runs large trade deficits ergo faces house price appreciation. This pattern is seen in the developed world.

    Something of a taboo topic btw…

  28. Gravatar of DonG DonG
    5. July 2017 at 17:48

    I remember that time a sock puppet was used to support an IPO for; That was animal spirits. No longterm effect, but 1999 was crazy time!

  29. Gravatar of Viking Viking
    5. July 2017 at 22:54

    Benjamin Cole,

    I agree with your trade deficit hypothesis, if we did not run a deficit, there wouldn’t be enough dollars among foreigners to inflate the RE markets. My personal opinion is that capital controls that freezes and over time eliminates foreign ownership of US equities and real estate would be an advantage. But this would in addition to eliminate the trade deficit also decrease the demand for treasury bills, so the US debt day of reckoning would be closer. You seem to think that debt can be monetized without any bad side effects. I am not confident this would be risk free.

    Anyway, I don’t really see what point you are making. Australian bank gave loans based on foreign income before. Today they don’t. Yesterday they were more permissive than most US banks, today they are not. What’s the big deal?

    10 years ago, stated income loans were common, today there is a requirement that US borrowers provide paystubs and dozens of other documents. Mainly this is a CYA for the banks. My impression is that the documents are not independently verified. On the second thought, the T-4506 form releasing the IRS transcript is required, so a major difference between stated and actual income could be detected.

    Sometimes brokerages publish lists of stocks that can’t be bought on margin. If bank strategists believe there might be a bubble, then there are obvious actions to take to mitigate risks. I am not arguing whether Sydney real estate is a bubble, but I would not buy bonds depending on Sydney mortgage repayments.

  30. Gravatar of Benjamin Cole Benjamin Cole
    6. July 2017 at 03:35


    My hypothesis it is not.

    It is the NY Fed that reports current account trade deficits are associated with house price “bubbles.”

    The author, Andrea Ferrero, also did a similar paper for the peer-reviewed Journal on Money Credit and Banking, which is supposed to be big stuff.

    Free trade or not, the truth is there are large unintended side-effects to trade imbalances in nations with zoned property. Honest academics should address this issue.

    The middle-class cannot buy a house in Sydney, Vancouver, London, Seattle, Los Angeles, New York, Boston etc. It is getting worse every year.

    So who is globalism working for, given real-world structural impediments in property?

  31. Gravatar of tpeach tpeach
    6. July 2017 at 03:50

    Hi Scott, the Economist has an editorial out titled;

    Germany saves too much and spends too little, we argue in this week’s cover editorial. Why its surplus is damaging the world economy.

    Would be great to hear your thoughts on this considering your previous posts on this issue!

  32. Gravatar of Major.Freedom Major.Freedom
    6. July 2017 at 05:07

    Steve F:

    “an issue I see is that it appears to be true that production incentives change based on spending. What is your response to something like how unstable money can cause reduction in incentive to produce; thus money does have a real effect on production?”

    Be careful about the fallacy of composition. While it is true that at the individual firm level, production is “incentivized” by the prospect of money revenues (demand), at the level of the economy as a whole, those revenues completely offset. At this level, the value of money, the incentive of acquiring it, is completely dependent on production. Without production as such, money is worthless as such. It is not correct to say that aggregate production is “incentivized” by aggregate demand. It is not true to say that more money and spending as such will “incentivize” production as such.

    I would not at all disagree with the statement that production changes when money changes. However healthy, sustainable and high production, requires real capital coordination, so that everyone’s savings and consumption patterns in real terms can find a place and affect the capital structure positively, as opposed to adversely with a socialist currency. Socialist currency is inherently and naturally “unstable”. Stability is not had when aggregate spending is forced to change by a subjective, arbitrary, non-market rate by a socialist currency printer. Any seeming stability within such a world is in spite of the currency printing, not because of it.

    And no investor plans according to “expected NGDP”. It is why people need to be bribed by academic donors to participate in betting on NGDP futures.

    Aggregate spending stability is a byproduct of an accidental stability in people’s valuations towards production conditions and money conditions. There is nothing necessary about it to ensure healthy economic growth. Any correlation that appears to show otherwise are always the result of other causes that make both aggregate production and aggregate spending decline.

  33. Gravatar of Patrick Sullivan Patrick Sullivan
    6. July 2017 at 06:49

    Wouldn’t we need a definition of ‘animal spirits’ first?

  34. Gravatar of Doug M Doug M
    6. July 2017 at 08:24

    Did Keynes really suggest that animal spirits drove growth? I have never read Keynes in the original, but I was under the impression that Keynes espoused that animal spirits drove the financial markets, but that the financial markets were effectively a side-show to economics… the tail of the dog, and real growth came from other factors such is rising levels of employment.

    Above you say.

    “Long run growth is driven by fundamentals: free markets, property rights, sensible taxes, low corruption, human capital, technology, peace, etc. Short run growth is driven by aggregate demand, i.e. monetary policy.”

    I would say that this is not entirely right either. Long-run growth comes from increasing productivity, or it comes from increasing labor force participation.

    Productivity comes from business investment and from technological improvement. I suppose superior job skills development and more efficient business practices need to be included in there. While peace and sensible tax policy and property rights provide greater incentives to invest, we are still talking about secondary factors.

    Monetary policy, over the short-term, is just at transformation of the coordinate system. Changing the yardstick, to change the measurement. Not growth.

    Over the long-term an inferior monetary policy can clearly destroy the incentive to invest. So, an efficient policy should contribute to long-run growth rate.

  35. Gravatar of Major.Freedom Major.Freedom
    6. July 2017 at 09:39

    “Long run growth is driven by fundamentals: free markets, property rights, sensible taxes, low corruption, human capital, technology, peace, etc. Short run growth is driven by aggregate demand, i.e. monetary policy.”

    In this passage there is also a conspicuous absence of utilitarianism, pragmatism, and advocacy of Rortyian relativism.

    This is of course because such concepts can be used to critique Sumner’s statements about what drives prosperity.

    The Rortyian could of course reject the entire passage as nothing but a vain appeal to truths of reality that are not actually knowable by anyone, that every word in the paragraph is nothing but an accidental, time bound set of definitions and social conventions that have no bearing on the actual substantive requirements for human prosperity.

    The pragmatist could dismiss it all as too cumbersome for politicians to understand and practise (by quitting, as one example), so the magic words of “not pragmatic” is chanted and that’s that. We live under the yoke of an elite, so shut up and stop trying to demagogue the issue.

    The utilitarian could doodle some silly equations on paper that tells us that when we compare the gains to some people and the costs to others, oh look my numbers say the entire paragraph fails the utilitarian test. Can’t prove me wrong because we’re already in a framework of sterile, self-justifying utilitarian metrics.

    What drives growth is the individual seeking to achieve growth, and that can only happen when the individual is unencumbered and free from threats of violence or actual violence against their person or homesteading/traded property. Period, end of story. I cannot force you to grow, and you cannot force me to grow. We could only grow from our own actions, if the other stays the hell out of the way of the other in terms of actionable valuations of scarce material means, including our bodies. That means, as one example, to stop siccing socialist currency manipulators on everyone, including me. You don’t own me or anyone else, you don’t rule me or anyone else, so why pretend that you do? You are kidding yourself. Property rights are systematically violated by states in order for central banks to een exist. Central banks are not free market institutions. They are not even democratic ones for that matter. They are institutions based on deception, illusions, secrecy, and ultimately naked aggression and coercive power.

    Why do my books need to be exposed inside and out to the state, when the state’s own central bank is not subject to such exposure? This is not equal rights. It is socialism.

  36. Gravatar of Steve F Steve F
    6. July 2017 at 09:57


    You said, “Aggregate spending stability is a byproduct of an accidental stability in people’s valuations towards production conditions and money conditions. There is nothing necessary about it to ensure healthy economic growth”

    Are you talking over a long term? If we’re talking an unlimited amount of time, I would agree and so would Friedman. However, in the short term, the first part of what you said appears to necessarily mean the last part is not true. If the money monopolist malfunctions and peoples’ perceptions of money conditions change for the worse, then it necessarily has an effect on growth even if just nominal. Reasons this matter are the behavioral phenomena where prices are sticky and wages pace the nominal instead of the real.

    Do you believe that what the Fed does has no effect on the economy at the point in time? What do you think would happen if today the Fed cut the money supply down to 2% of current?

  37. Gravatar of Jerry Brown Jerry Brown
    7. July 2017 at 11:42

    I agree with Doug M. @8:24. And Doug, my advice is to never promise to read Keynes in his own words- it is a miserable experience. I promised Sumner that I would read the General Theory a while back just because I disagreed with one of Scott’s interpretations. This was a huge mistake- a month long project has turned into a five year plan and now maybe a lifetime goal that I would be happier not fulfilling. Save yourself from this burden!

  38. Gravatar of Scott Sumner Scott Sumner
    8. July 2017 at 06:25

    tpeach, I’ve done many posts on that already, but I’ll take a look.

    (Some are at Econlog)

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