# Understanding Animal Spirits in Finance: Definition, Impact, and Examples

## What Are Animal Spirits?

"Animal Spirits" refers to the psychological and emotional factors influencing financial decisions during economic uncertainty. Coined by economist [John Maynard Keynes](https://www.investopedia.com/terms/j/john_maynard_keynes.asp), it highlights how emotions like [consumer confidence](https://www.investopedia.com/terms/c/cci.asp) and fear drive market behaviors and investor actions, affecting economic growth and market stability. This article explores the origins, significance, and examples of Animal Spirits in financial contexts.

The term comes from the Latin spiritus animalis, meaning "the breath that awakens the mind." In some ways, Keynes' insights into human behavior predicted the rise of [behavioral economics](https://www.investopedia.com/terms/b/behavioraleconomics.asp).

### Key Takeaways

*   "Animal spirits" is a term coined by John Maynard Keynes to describe how human emotions influence financial decisions during economic stress.
*   In finance, animal spirits explain the psychological factors, like confidence and fear, that drive market behavior and investor actions.
*   The concept suggests that human emotions play a significant role in creating phenomena such as market bubbles and panic selling.
*   The 2008 financial crisis and the Dotcom Bubble exemplify the impact of animal spirits on market volatility and economic downturns.
*   Critiques of the theory argue that while emotions affect markets, efficient market hypothesis suggests individual irrationality may cancel out in the aggregate.

![John Maynard Keynes](https://www.investopedia.com/thmb/ynIM9Jf31rIaZTn3zBMFtSP9sgo=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/john-maynard-keynes-keynesian_final-292eaf637ac0477db8ba73f466dd0912.png)

*— Investopedia / Bailey Mariner*

## Key Concepts Behind Animal Spirits

The technical concept of _spiritus animalis_ can be traced as far back as 300 B.C., in the fields of human anatomy and medical physiology. There, animal spirits applied to the fluid or spirit present in sensory activities and nerve endings in the brain that resulting in mass psychological phenomena like manias or hysterias.

Animal spirits also appeared in literary culture, where they referred to states of physical courage, gaiety, and exuberance. The literary meaning implies that animal spirits can be high or low depending on an individual's degree of health and energy.

## How Animal Spirits Influence Financial Markets

Today in finance, the term animal spirits arise in [market psychology](https://www.investopedia.com/terms/m/marketpsychology.asp) and [behavioral economics](https://www.investopedia.com/terms/b/behavioraleconomics.asp). Animal spirits represent the emotions of confidence, hope, fear, and pessimism that can affect financial decision-making, which in turn can fuel or hamper economic growth. If spirits are low, then confidence levels will be low, which will drive down a promising market—even if the market or economy [fundamentals](https://www.investopedia.com/terms/f/fundamentals.asp) are strong. Conversely, high spirits boost confidence and can cause market prices to rise.

> **Tip**
>
> Animal spirits can give rise to bubbles in asset prices, and also can lead to panic selling.

### Emotional Drivers in Business Decision-Making

According to the theory behind animal spirits, the decisions of business leaders are based on intuition and the behavior of their competitors rather than on solid [analysis](https://www.investopedia.com/terms/f/financial-analysis.asp). Keynes understood that in times of economic upheaval, irrational thoughts might influence people as they pursue their financial self-interests.

Keynes further posited in _The General Theory_ that trying to estimate the future [yield](https://www.investopedia.com/terms/y/yield.asp) of various industries, companies, or activities using general knowledge and available insight "amounts to little and sometimes to nothing." He proposed that the only way people can make decisions in an uncertain environment is if animal spirits guide them.

### Modern Perspectives on Animal Spirits

In 2009, the term animal spirits returned to popularity when two economists—George A. Akerlof (Nobel laureate and professor of economics at University of California) and Robert J. Shiller (professor of economics at Yale University)—published their book, _Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism_.

Here, the authors argue that although animal spirits are important, it is equally important that the government actively intervene to control them—via economic policymaking—when necessary. Otherwise, the authors postulate, the spirits might follow their own devices—that is, capitalism could get out of hand, and result in the kind of overindulgence that we saw in the 2008 financial crisis.

The five cognitive and psychological types of animal spirits identified by Akerlof and Shiller include following. These phenomena help economists consider answers to tricky questions such as "why do economies fall into depression" and why are financial prices and corporate investments so volatile?"

*   Confidence
*   Corruption
*   Money Illusion
*   Fairness
*   Stories

## Real-World Case Studies of Animal Spirits

### The Dotcom Bubble

Animal spirits often manifest as market psychology defined by either fear or greed. For the latter, the term "[irrational exuberance](https://www.investopedia.com/terms/i/irrationalexuberance.asp)" has been used to describe investor enthusiasm that drives asset prices far higher than those assets' fundamentals justify. Simply tacking on "dotcom" to the name of a company increased its market value to extraordinary levels, with startups showing zero earnings commanding ever-higher share prices.

The [crash](https://www.investopedia.com/terms/d/dotcom-bubble.asp) that followed saw the Nasdaq index, which had risen five-fold between 1995 and 2000, tumble from a peak of 5,048.62 on March 10, 2000, to 1,139.90 on Oct 4, 2002, a 76.81% fall. By the end of 2001, most dot-com stocks had gone bust.

### The Great Recession

Another example was the lead-up to the 2008-09 financial crisis and the [Great Recession](https://www.investopedia.com/terms/g/great-recession.asp), when the markets were rife with financial innovations. Creative use of both new and existing financial products—like [collateralized debt obligations](https://www.investopedia.com/terms/c/cdo.asp) (CDOs)—abounded, particularly in the housing market. Initially, this trend was thought to be positive, that is until the new financial instruments were found to be deceptive and fraudulent. Investor confidence collapsed, triggering a sell-off and causing markets to plunge. A clear case of animal spirits run amok.

## Debating the Validity of Animal Spirits Theory

"Animal spirits" refers to the tendency for investment prices to rise and fall based on human emotion rather than [intrinsic value](https://www.investopedia.com/terms/i/intrinsicvalue.asp). This theory, however, has been critiqued by some economists who argue that markets are nonetheless [efficient](https://www.investopedia.com/articles/basics/04/022004.asp) and that individual irrationality washes out in the aggregate. The animal spirits thesis, like behavioral economics, essentially throws a monkey wrench into the assumptions of efficiency and rationality.

Critics say bubbles result from central bank involvement and regulation, not mass psychology, disrupting growth and market balance. These ideas often come from Austrian economics or libertarianism, which blame money supply increases for bubbles and malinvestment.

## The Bottom Line

John Maynard Keynes introduced the concept of animal spirits to explain how human emotions such as confidence, hope, fear, and pessimism can influence financial decision-making and market outcomes. These psychological factors often drive consumer confidence and market psychology, leading to phenomena such as bubbles or panic selling, and challenge the traditional economic assumptions of rationality and efficiency. Understanding animal spirits and their impact on investing can provide insights into both the potential for irrational market behavior and the importance of managing emotions in financial decisions.  

> **Article Sources**
>
> 1.  Amazon. "[Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism.](https://www.amazon.com/Animal-Spirits-Psychology-Economy-Capitalism/dp/069114592X)"