How Animal Spirits Affect the Economy

Source details

Viral narratives may be the missing link between emotions and economic fluctuations.
Builds on Keynes’s concept of “animal spirits”—instincts and emotions that influence behavior such as spending or investing.
Draws on Robert Shiller’s hypothesis that sufficiently popular narratives can go viral and have society-wide impact (Shiller 2020).
Argues policymakers, researchers, and practitioners lack tools to identify narratives, measure their contagiousness, and quantify their contribution to economic events.

Key datasets: text of US public firms’ conference calls and Form 10-K filings.
Methods: a variety of natural language techniques ranging from simple dictionary-based methods to more complex algorithmic topic discovery.
Narratives identified: firms’ general optimism, excitement about artificial intelligence, adoption of new digital marketing techniques, and other topics.
Goal: translate textual data into empirical measures of how narratives drive firm decisions and spread across the US economy.

Companies with more optimistic narratives tend to accelerate hiring and capital investment.
Exact measured effect on hiring: the pace of hiring at a company that uses optimistic language increases by 2.6 percentage points more in a year than a comparable company that uses pessimistic language.
This hiring effect is above and beyond what would be predicted by firms’ productivity or recent financial success.
Firms with optimistic narratives do not see higher stock returns or profitability in the future and make overoptimistic forecasts to investors.
Narrative contagion: companies tend to adopt the narratives of their peers, starting within groups of peer firms that directly compete in the same industry and then spreading to the aggregate level.
Narratives that arise at large companies have an especially large effect, suggesting large companies may act as thought leaders in the narrative economy.

Developed a macroeconomic model in which contagious narratives spread between firms and amplify economic fluctuations.
Contagion implies that even a one-time shock can have long-lasting effects because a negative mood can infect the population and hold back business activity.
Defined phenomenon: narrative hysteresis — sufficiently contagious narratives that cross a virality threshold can induce stable, self-fulfilling periods of optimism or pessimism via a feedback loop between economic performance and reinforcing narratives.
Empirical estimates using the model and measurements:
- Narratives explain about 20 percent of fluctuations in the US business cycle since 1995.
- Narratives explain about 32 percent of the early 2000s recession.
- Narratives explain about 18 percent of the Great Recession of 2008–09.
Additional patterns:
- Overall mood of the US economy fluctuates slowly around a long-term average.
- Individual narratives (e.g., surrounding new technologies) tend to be more volatile and are more likely to go viral and fully infect the population.
- A constellation of fast-moving fears and fads contributes to the relatively stable behavior of aggregate economic sentiment.

1. What people say is highly informative about individual attitudes and broader economic trends.

Public regulatory filings and earnings calls contain valuable information.
Policymakers and researchers can use improved machine learning algorithms and data processing tools to analyze these sources.
Implication for data collection: novel surveys that allow households or businesses to explain the “why” behind their attitudes and decisions have increased value (Andre and others 2024).

2. Some narratives are more influential and contagious than others.

Important to combine descriptive measurement of narratives with empirical analysis of their effects on decisions and their spread.

3. Policy-introduced narratives can have significant impact.

Open question: what makes a policy narrative into a compelling story (example raised: Mario Draghi’s unscripted “whatever it takes” remarks)?

Overall: the study of narrative economics is in its infancy; detailed understanding of origins, spread, and economic consequences of narratives could change how we collect information and explain business cycle dynamics.

Podcast summary: Karthik Sastry discusses how animal spirits and economic narratives help gauge emotions driving financial decisions; John Maynard Keynes’s emphasis on animal spirits is highlighted.

How Animal Spirits Affect the Economy, JOEL FLYNN and KARTHIK SASTRY, March 2025.

How Animal Spirits Affect the Economy
- How Animal Spirits Affect the Economy (Markdown version)
- How Animal Spirits Affect the Economy (PDF)