Capturing the Elusive Animal Spirits

Abstract Economics have embraced rational expectations as a tool to model economic behaviour, yet ample evidence suggests that rational expectation models do not fit macroeconomic data (e.g. Fuhrer, 2000). This paper provides a consistent explanation for the conditions under which such radical changes of hearts, first coined by Keynes as 'animal spirits', occur: if a sequence of past events is interrupted by an event in opposite direction then agent's beliefs change instantly, dramatically and significantly different from the predictions of the Rational Expectations Hypothesis of Muth (1961). Another revealing result of the empirical analysis is that it seems that the labour market is the payground of animal spirits. The policy imlications of the findings are significant. Recommendations are made for firm's HR-strategies.