ANIMAL SPIRITS, ECONOMIC POLICIES AND BUSINESS CYCLES: THE THREE MUSKETEERS OF THE ECONOMIC WORLD

Abstract

This study quantifies animal spirits by constructing an index using information from major sectors of the economy. The key drivers of the animal spirits are the monetary/fiscal policies and the stage of the business cycle and therefore the effect of these drivers on animal spirits is also estimated. Furthermore, the effect of changes in the animal spirits index is generated to examine which sector is affected the most by animal spirits. In other words, we test whether animal spirits produce asymmetric effects on the economy. Our work suggests a policy change (and a shock/recession) produces dual effects on the economy which are (a) direct effects and (b) indirect effects, which is brought about by animal spirits. Therefore, it is crucial for policymakers to estimate the direct and indirect effects of policy changes as well as shocks/recessions on the economy to gauge the accumulative effect, rendering them more to design effective policies.