Animal Spirits in America, April 2009

TL;DR

This paper explores how adaptation level theory explains American confidence levels, linking animal spirits to unemployment sensitivity and using a model that successfully forecasted past economic turning points, now predicting recovery in mid-2009.

Contribution

It introduces a psychophysical model of confidence based on adaptation levels and combines it with yield curve data to forecast recession turning points.

Findings

Model correctly predicted all past economic turning points.

Forecasts confidence recovery in mid-2009.

Links confidence to unemployment and macroeconomic volatility.

Abstract

Adaptation level and animal spirits (Middleton 1996) presented a psychophysical theory of confidence levels based on the oldest and probably most widely observed law in psychology, the sensitivity to adaptation level. For Americans, whose attachments to employment and livelihood are often tenuous in a country without a European-style social safety net, it is the sensitivity to the unemployment rate that drives confidence levels. In Animal spirits and recession forecasting (Middleton 2001; see also Ball 2001), the adaptation level theoretic metric of animal spirits, A, was combined with the slope of the U.S. Treasury yield curve in a logistic recession forecasting model that has correctly predicted every turning point in the economy since then. The model currently forecasts increasing confidence and an end to the recession in mid-2009. The question, given the severity of the current slump globally, is whether this forecast is plausible in the face of possibly very large increases in macroeconomic volatility.