Akerlof and Shiller, Animal Spirits Confidence – Keynes-Minsky Hopes, Exuberance, Fears Waves of optimism and pessimism Corruption - Bad Faith  Loss of Trust S&Ls – Enron – Sub-prime Fairness Punish cheaters, even at own expense Relative position Money illusion “Illusion” is real in view of nominal contracts/accounts Stories New eras – Irrational exuberance  Downward wage rigidity

Akerlof and Shiller: A brief history of macroeconomics Pre – Keynes: Say’s Law  Automatic adjustment to full employment Keynes: Animal spirits  Excesses  Inherent instability Minsky, JMK, Stabilizing an Unstable Economy, Can “It” Happen Again? Hicks: IS – LM  Keynes without animal spirits Consumption function – Liquidity preference function Hydraulic Keynesians Original Phillips Curve  Policy Menu Friedman: Monetarist counter-revolution Dispense with money illusion/enter expectations/natural rate  Wage Setting: W = P e F(u,z) New Classical Economics Rational expectations Real business cycles (dynamic stochastic general equilibrium) New Keynesian Economics Rational expectations – but sticky adaptation

Akerlof and Shiller: Prescription for Today A Second Target – A Credit Target “It is fairly easy now to project the fiscal and monetary stimulus necessary for aggregate demand to be at full employment—if financial markets are freely flowing…But, with the loss of confidence in the financial sector, macroeconomic planners must have a second target…—the amount of credit that would normally be given [to qualified borrowers] if the economy were at full employment.” Methods: Discount window (TALF)/Capital injections/GSEs Gotta replace the fallen Humpty-Dumpty (Securitization) A Credit Target—Whom to credit? Bernanke and Blinder (1988) Credit, Money and Aggregate Demand, AER, May. – In liquidity trap, expansion of credit is effective stimulus Aside: Also in AER, May Akerlof and Yellen, Fairness and Unemployment “…where it is advantageous to pay some employees highly, it is also … fair to pay other employees well.” Unfair pay  shirking