Motivation during the financial crisis

Textbook, 2011

96 Pages, Grade: 1




motivation to conduct this study

I. Introduction
1.LIterature review of economic crisis
1.1. The Return of Depression Economics- Why do market economies experience recessions?
1.1.1 What are economic recessions?
1.2. Theories and Explanations of Economic Crisis
1.2.1. Earlier Views of financial crisis
1.2.2. The most Prominent Views on Financial Crisis: The Role of Asymmetric Information and Moral Hazard
1.2.3. Predictors of Financial Crisis
1.3. What happened in 2008? – How Psychology Drives the Economy
1.3.1. Animal Spirit 1. : Confidence and its Multipliers
1.3.2. Animal Spirit 2: Fairness
1.3.3. Animal Spirit 3: Money Illusion
1.4. Earlier Psychological Empirical Research about Financial Crisis
2.LIterature review: MOTIVATION
2.1. Early Developments in Motivation Theory
2.2. The Birth of the Content Theories
2.3. The Golden Age of Motivation Theories- The Area of Process Theories
2.4. Job Characteristics Model (JCM)
2.4.1. Affective Reactions to the job: Positive personal outcomes
2.4.2. The validity of JCM

4.1. Sample
4.2. Measures
4.3. Procedure
5.1. Descriptive Statistics
5.2. Hypotheses testing- using Regressions
5.2.1. Testing the assumptions of linear regressions
5.2.2. Testing Hypothesis 1
5.2.3. Testing Hypothesis 2
5.2.4. Testing Hypothesis 3: The moderating effect of procedural constrains
5.2.5. Testing Hypothesis 4a: Relationship between the job characteristics and autonomy’ /‘task variety’ and labor productivity
5.2.6. Testing Hypothesis 4b: Relationship between the job characteristics and ‘autonomy’ /‘task variety’ and service (or product) quality relative to the industry average
5.3. Additional Results
5.4. Testing the mediating role of GNS
6.1. Implications for Theory
6.2. Implications for Practice
6.3. Limitations of the study and implications for future research


1. definitions of the core dimensions of Jcm with examples

2. Summary of THE MAIN Demographic data

3. mean and the standard deviation of each job characteristic and values found by sims et al. 1976

4. Results of multinominal log regression with productivity as DV

5. Results of multinominal log regression with QUALITY as DV

LIST OF Figures



3.a. PP Plot



5.Differences in JCm variables between subjects who lost and kept their job during the crisis




The purpose of this thesis is to address the impact of the financial crisis of 2008 on changes in motivation, and job characteristics proposed in the Job Characteristics Model. The sample consisted of 272 subjects from different industries. Regressions and multinominal logistic regression were used to analyze the hypotheses of the study. This study has provided only partial support for the applicability of the JCM during economic crisis. Whereas dealing with others, task identity and autonomy predicted the levels of internal work motivation significantly; the other job characteristics did not lead to significant results. Other than expected GNS did not moderate the relationship between the job characteristics and motivation, however, interestingly it had a mediating role between autonomy/dealing with others and motivation. Procedural constrains did not have an effect on motivation. The results generally support the Job Characteristics Model’s predictions that task variety and worker autonomy are positively associated with labor productivity. The quality of products and services on the other hand, was only associated with task variety.


Das Ziel dieser Studie war es, die Effekte der Wirtschaftskrise von 2008 auf die Motivation und auf den Kerndimensionen des Job Characteristics Models zu untersuchen. Insgesamt haben 272 Teilnehmer aus verschiedenen Industrien an der Studie teilgenommen. Die Ergebnisse wurden mit Regressionen und multinominalen Regressionen ausgewertet. Die Hypothesen der Studie konnten nur teilweise bestätigt werden. Außer den Umgang mit Anderen, Autonomie und Aufgabenidentität hatten die restlichen Variablen des JCMs keinen Effekt auf die Motivation. Im Gegensatz zur Annahme des JCMs und früheren Studien die die Rolle des GNS (Zufriedenheit mit persönlichen Entfaltungsmöglichkeiten) als Moderatorvariable bestätigt haben, konnten diese Ergebnisse in dieser Studie nicht reproduziert werden. GNS fungierte als Mediatorvariable zwischen dem Umgang mit Anderen, Autonomie und Motivation. Die Verfahrungsbeschränkungen am Arbeitsplatz hatten keinen Effekt auf die Motivation. Autonomie und Anforderungswechsel hatten einen positiven Effekt auf die Produktivität im Unternehmen. Die Qualität der Produkten/Dienstleistungen wurde nur von dem Niveau des Anforderungswechsels beeinflusst.

Motivation to conduct this study

In 2008, the “normal working environments” changed in many organizations, due to the devastating outcomes of the financial crisis. This sudden change of organizational, political and economical context generated new topics in the field of organizational research.

Recessions are, as Paul Krugman (2008) defined them “peculiar occurrences”, which were mostly studied by economists, whose main goal was to develop models which would help experts and the governments to prevent economic catastrophes, such as the Great Depression. But one important aspect was left out in these highly complex economic models; namely the people themselves. Identifying factors and events that signalize economic turbulences is surely an important issue, but one should not forget that these events do not occur randomly. They are always embedded in a social context. Bank panics, higher inflation, declines in stock markets or increases in prices sometimes struck us as a surprise, but they are only a result of people behaving in a certain way. People decide whether they want to spend or safe their money, whether they want to take up a mortgage or invest in stocks; therefore they are the main driving force of economy. Most literature in economics focuses on explaining and predicting the onsets of recessions, but such research rarely considers people and their feelings, fears or behavior during unstable economic times. There is a very small body of psychological and sociological research on this topic thus, many questions still remained unanswered. We still have little scientific insight about the effects of financial crisis on psychological factors such as: motivation, job-satisfaction, working morale and many others. In this thesis, I choose to focus on motivation, mostly because it is one of the most essential prerequisites for success and effectiveness of organizations.

The purpose of the present study is (a) to test the effects of the financial crisis on motivation using the job characteristics model (b) to explore the role of growth need satisfaction and procedural constrains as moderators between job characteristics and motivation; (c) to test all of the above relationships in a financial crisis setting.

The thesis is structured as follows: the introduction is divided into two parts, in the first part I summarized the literature about financial crisis and I linked it to issues and phenomena of psychology. The second part of the introduction is dedicated to motivation theories and literature based on studies with JCM (which is used as a theoretical basis for this study). In the hypotheses section, the assumptions and expectations of this study are explained and justified. In method section I describe the materials, procedure and sample of the study. In the subsequent section the results of the study are presented, which are then discussed in the last chapter of the thesis.



1.1. The Return of Depression Economics- Why do market economies experience recessions?

“It got drunk and now it’s got a hangover.” This is how George W. Bush commented on the Wall Street’s troubles (The Economist, 9 August 2008, as cited in Chorafas, 2009) . But now the whole world has to face the consequences of their drunkenness (Akerlof & Schiller, 2009). About fifteen years ago hardly anybody expected that modern countries will have to face “bone-crushing recessions”, that they will not be able to pay back debts, let alone go bankrupt. World’s economy turned out into a more dangerous place, than ever expected and economists and policy makers were not ready to face it.

Sorrowful pictures of hungry children, hopeless mothers and unemployed men marching on the streets of American towns, are the only traces that people associate with the Great Depression nowadays. However, the Great Depression lead to a massive joblessness all around the world; in the U.S. unemployment reached 26%, in the United Kingdom it rose above 27%, whereas in Germany it reached a maximum of 34%. Despite of the devastating consequences, the Great Depression was quickly forgotten. At least until 2008 when America’s mortgage crisis spiraled into the largest international financial shocks since the Great Depression. In the first quarter of 2009, the Brookings Institution reported an annualized GPA decline rate of 14.4% in Germany, 15.2% in Japan, 7.4% in the UK, 9.8% in the Euro area. Nevertheless, despite the financial losses and the increased unemployment rates in the last two years, a full-blown -financial collapse, as the one during the Great Depression, where one-third of the U.S. banks failed, and the unemployment rate rose to 25 percent, could have been prevented due to policy actions and bail-out packages of the governments (in Shah, 2010).

1.1.1 What are economic recessions?

What is a depression in economics and can it be prevented? In this chapter I will summarize economic literature on recessions, and give an overview of the major theories on this topic.

The National Bureau of Economic Research defines economic recession as “a significant decline in the economic activity spread across the economy, lasting more than a few months”. The United States suffered its first recession back in 1797 which was primarily caused by the deflating effects of the Bank of England as they crossed the Ocean to America. Recessions continued to plague throughout the history, not only America, but the rest of the world as well. Today economic recessions are considered to be a part of the natural cycle of the modern economic system that cannot be escaped in the long run. Countries like Germany, the U.K., China, and Japan have all had trouble with recessions ( 2010). Recessions are peculiar occurrences, especially because economy is based on a premise that markets usually manage to match supply and demand. In times of recessions there are enough good factories, retailers and shops but there are no consumers, there are plenty good workers who are willing to works for less money, but there is a lack of jobs. In other words, there is a surplus of supply but there is no demand (see Krugman, 2009).

In his books Paul Krugman (2009), a Noble Price winning economist, uses a very simple story to demonstrate what recessions really are, and how they emerge. The original story that he uses in his works, was published in 1978, by R. Sweeney who was a member of the cooperative under the title “Monetary Theory and the Great Capitol Hill Baby-sitting Co-op Crisis”. The baby-sitting co-op was a large association of 150 young couples, who were willing to baby-sit each other´s children. To ensure that all couples provided exactly as many hours of baby-sitting as received, a special coupon system was introduced. For each hour the baby-sitters received a coupon from the baby-sitees; at the end of a certain time period all couples had to have the same number of earned coupons. The co-op may seem easily manageable but it turned out that such a system required a fair amount of scrip in circulation. Couples tried to accumulate as many reserves for the future as possible, which lead to an imbalance in the system; suddenly there were many baby-sitters but no there was a lack of baby-sitting opportunities. Consequently, the co-op fell into a recession. Certainly, the co-op did not fall into a recession because the members did a bad job, or because they lacked special “baby-sitting techniques”. The problem therefore, was not the co-ops ability to produce, nor to supply the market, but simply a lack of demand. The “real economy” even of small countries is surely much more complex than the baby sitting co-op. Among many other additional factors, in real economies people do not spend money only for current pleasures; they also invest in the future. In real economies there is also a capital market in which those with spare cash can lend at certain interest rates to those who need it. But the fundamentals are the same as; a recession is normally a matter of the public as a whole trying to accumulate money (or trying to save more than they spend) (see Krugman, 2009).

Ever since the Great Depression economists and policy makers became attentive to the problems of recession in financial markets. But the focus of their concern changed through the history, since more and more factors were associated with an onset of a recession. In the subsequent sections of this thesis I would like to focus on theories and explanations of financial crisis and the change of views through time.

1.2. Theories and Explanations of Economic Crisis

1.2.1. Earlier Views of financial crisis

The collapse of the financial system during the Great Depression struck the attention of economists. New models had to be developed to prevent such catastrophic recessions in the future. The first work on financial crisis was published in the first volume of Econometrica in 1933, in which Fisher argued that the severity of the Great Depression resulted from poorly performing financial markets. In his view the economy became extremely vulnerable due to high leverage of the borrowing class in the wake of prosperity preceding 1929, which lead to a wave of bankruptcies and deflation. According to Fisher, the economy got stuck in a vicious circle; deflation redistributed wealth from debtors to creditors and lead to a decline in net worth, which in return induced borrowers to cut back on current expenditures and future investments, sending the economy further down the spiral (Gertler, 1988).

Also inspired by the devastating causes of the Great Depression, John Maynard Keynes published his masterwork called “The General Theory of Employment, Interest and Money”. In his work Keynes described how creditworthy governments could borrow and spend, and thus reduce unemployment and put economy back “to work”. In the 1940´s Keynesian principals for fighting recessions became fully incorporated into government policies as well as into the thinking of economists and politicians (Akerlof & Schiller, 2009). General Theory is very complex, but its main conclusions can be summarized in four bullet points:

- Economies often suffer from an overall lack of demand which usually leads to involuntary unemployment
- It is questionable if economy posses an automatic tendency to correct shortfalls in demand. If this tendency really exists, it operates slowly and painfully
- Government policies aimed at increasing demand, can reduce unemployment quickly
- Sometimes increasing the money supply won’t be enough to persuade the private sector to spend more, and government spending must step into the breach

Although these points might not sound revolutionary to modern economists and policy makers, they were not only radical in times when Keynes presented them, but rather unthinkable. Over the past 70 years The General Theory has been a base of many economic theories and views (Krugman, 2006).

In the 1970´s theories about financial crisis were split into two opposite camps; those linked to monetarists such as Friedman and Schwarz, versus more eclectic theories such as the one proposed by Kindelberger and Minsky. Monetarists connected financial crisis with bank panics, which were viewed as the major source of contractions in money supply, that in turn have always led to severe contractions in economic activities. According to monetarists sharp declines in asset prices and business failures alone do not constitute a real financial crisis if they are not accompanied by bank panic. Without bank panics declines in economic activities are characterized as “pseudo- crisis”. During pseudo-crisis government interventions are not necessary. On the contrary, they can be rather harmful because such interventions can lead to a decrease in overall economic activity since firms that actually deserve to fail receive an unnecessary bailout (Mishkin, 1992). Kindelberger (1978) and Minsky (1972, as cited in Mishkin, 1992, p. 116) proposed a much broader definition of what constitutes a real financial crisis than the monetarists. They considered sharp declines in asset prices, failures of financial as well as nonfinancial firms, extreme inflations and disinflations or a combination of all of these factors, as “real signs” of a financial crisis, which do not necessarily have to be followed by bank crisis. They saw these disturbances as serious threats to the aggregate economy and they advocated the importance of government interventions in such times. Since they did not offer a clear definition of financial crisis their view was not considered as a valid theory, and thus it lent itself to being used too broadly as a justification for government interventions that might not always be useful for the economy. On the other hand, the monetarist view is extremely narrow because it only focuses on bank panics (Mishkin, 1992).

Another example of the early views on crisis are the so called exogenous-policy models or models of speculative attacks, pioneered by Krugman (1979, as cited in Zhu & Jiawen, 2008, p.210). The essence of these models is that currency crises are unavoidable outcomes, mostly caused by inconsistencies of economic policies. Domestic credit expansion, chronic structural imbalances such as current account deficit, domestic fiscal imbalances, or combinations of these factors cause excess demand for foreign currency and drain the country´s international reserves. When reserves are exhausted, the country will have no choice but to let go of the fixed exchange rate policy, and currency crisis become unavoidable.

The second generation of models uses a game-theory approach. These models focus on government optimization and views devaluations as a result of choosing between conflicting policy targets (Zhu & Jiawen, 2008). One of the most prominent examples of these second generation models is a stochastic model of economic crisis which is based on the ideas of of Romer (1990) and by Grossman & Helpman (1991) and was developed by Obstfeld (1994, p.1311). Her model supposes that each county can invest in two linear projects: a safe one and a risky one. However, ongoing growth depends on investments in supplying specialized, risky production inputs, because risky investments usually have higher expected returns than safe ones. Since international asset trade allows each country to hold a globally diversified portfolio of risky investments, it encourages all countries to shift from low-return, safe investments toward high-return risky investments. Nevertheless, when all countries chose to maximize profit, and invest only in risky assets, recessions become unavoidable.

1.2.2. The most Prominent Views on Financial Crisis: The Role of Asymmetric Information and Moral Hazard

Transactions which take place in financial markets are usually based on asymmetric information, in which one party often does not have all the necessary knowledge she/he might need about the other party. Krugman (1979) was the first one to introduce incomplete knowledge on the part of investors as a predicator of a financial crisis. Incomplete knowledge leads to a higher uncertainty during decision making. For example, borrowers who take out loans often have better information about potential returns and risks associated with their own investments than the lenders. On the other hand, lenders may have more information about possible market developments and interest rates than a lay borrower who needs a mortgage for a house. Asymmetric information creates a problem in two different ways: before the transaction is entered into (adverse selection) and after the transaction is entered into (moral hazard). Adverse selection describes a problem in the financial markets which occurs when the potential borrowers who are most likely to produce undesirable outcomes, are the ones who have the highest chance of getting a credit. Adverse selection makes it more likely that loans might be given to “bad” borrowers, therefore lenders may decide not to give any loans even though there are some good investment opportunities in the marketplace (see Mishkin, 1992). This situation is a feature of the classic “lemons problem”, which was described for the first time by Akerlof (1970).

In order to capture the essence of the adverse selection problem or as he defined it the “lemons problem” Akerlof uses an example with used cars. In order to simplify the explanation Akerlof suggests that cars can be divided in exactly four categories; used and new cars on one side, and good and bad cars (called “lemons” in America) on the other. A new car may be a good car or a lemon. The same is true for used cars; they can be “lemons” or in perfectly good shape. Individuals who decide to buy a car usually do not know if they will buy a good car or a lemon. But what they do know is that with a probability p the desired car is actually a good one, and with probability (1-p) it may be a lemon (p being the proportion of good cars produced and 1-p the proportion of the lemons on the market). But some people can give more accurate estimates of these probabilities than others. For example, after owning a Mercedes car dealership for years, the dealership owner can form a better idea about the quality of the certain Mercedes model, and thus he can assign a more accurate estimate of probability that the car is a lemon, than a potential buyer who never drove a Mercedes in his life. An asymmetry in available information has been developed at this point. The dealership owner has more information about the car the potential buyer. Therefore, he can sell good cars and lemons at the same price, since it is impossible for the buyer to tell a difference between a good car and a lemon, especially if the car is brand new. It is obvious that a used car cannot have the same valuation as a new car; but if it could have the same valuation, it would be advantageous to trade a lemon at the price of a new car, and buy a new car (at higher probability p that it is a good car). However, in this case most people will not buy a car at all, in order to prevent buying a lemon, and owners of good cars will want to hold on to their cars as long as they can and will not want to sell it. Therefore, most cars traded will be lemons and good cars may not be traded at all; so bad cars will drive out the good ones from the market (see Akerlof, 1970). As pointed out by Myers & Majluf (1984) a lemons problem occurs at financial markets when the lenders have trouble determining whether a lender is a good risk with a profitable investment opportunity, or if he is a bad risk with bad investment projects which has high risks.

Moral hazard in financial markets occurs when lenders are subjected to a hazard, since borrowers might engage in activities which are undesirable (immoral) from the lender´s point of view. Moral hazard is a result of asymmetric information in the financial markets. It is a result of lender´s lack of information (or in some cases control) which enables the borrower to engage in moral hazard. But moral hazard is not necessarily a result of asymmetric information; it can also occur due to high enforcement costs, which lenders have to pay to prevent moral hazard. Even when lenders learn about undesired activities of borrowers, legal costs are often too high, so it is too costly for the lender to prevent moral hazard. Moral hazard also occurs because borrowers usually have incentives to invest in projects with high risks, mostly because risky investments bring the most profit if they succeed. But if they fail, lenders have to bear most of the costs. Borrowers might also misallocate funds for their own personal use, they can also choose to work less than required on a certain project or take unprofitable investment on purpose only to increase their own power or stature. The conflict of interest between lenders and borrowers caused by moral hazard may cause the same problems as those caused by asymmetric information; lenders can decide not to lend any money at all, and if they decide to lend they will ask high interest rates in return, thus borrowers who are most likely to produce an undesirable outcome through risky investments are the ones most likely to get a loan (see Mishkin, 1992).

Insurance companies are one of the most prominent examples of moral hazard in economy. Insurance companies profit the most when people pay to avoid risk. Their customers pay smaller amounts of money, but break even in cases of misfortunes, since insurance companies cover their losses. Therefore, insurance companies lower the costs of misfortune. Sometimes insured people become sloppier; they forget to lock doors or drive more aggressively, because they know that their insurance will cover their losses. They simply make less effort to avoid misfortune, and this change in behavior is a good example for moral hazard. For example, if a person has to pay $1000 to repair his/her car damage but insurance pays $900, the insured person has an incentive to avoid the accident. On the other hand if the accident costs the person $1000 but the insurance pays $2000, the person not only has no incentive to avoid the accident but may have an incentive to seek it out consciously (Schenk, 2007).

1.2.3. Predictors of Financial Crisis

Mishkin (1992, 1995) sees five primary factors in the economy as predictors and enhancers of moral hazard and adverse selection.

Increases in interest rates: If interest rates increase sufficiently, due to an increased demand for credits or due to a decrease in money supply, there is higher probability that lenders will lend to bad credit risks with risky investments, because good credit risks might not be willing to borrow because exceptionally high interest rates make projects less profitable, while bad credit risks might use this opportunity to get a loan even with higher interest rates. Mankiw (1986, as cited by Mishkin 1992, pp. 118) demonstrated that a small rise in the riskless interest rate can sometimes lead to a very large decrease in lending and even a possible collapse in the loan market.

Stock Market declines: Sharp stock market declines cause an increase in adverse selection and moral hazard because they lead to large declines in the market values of firm´s net worth. As a result, lenders are less willing to lend because they have less protection and certainty. Firms losing their net worth are less likely to pay back credit, so losses from loans are more likely to be severe.

Increases in uncertainty: Failures of prominent financial institutions or big non- financial organizations, stock market crashes or recessions usually cause dramatic increases in uncertainty in financial markets. The increase of uncertainty makes information more asymmetric and makes adverse selection even more severe. Similarly to scenarios with sharp stock market declines, lenders are also less willing to lend because there is very little guarantee that firms will be able to pay pack the loans.

Bank Panics: is a factor which was adopted from the Monetarists. Banks play an important role in financial markets because they reduce the adverse selection problem by becoming experts in the production of information about firms. Therefore, they are able to sort out good credit risks from bad ones. Thus, a crisis which results in bank panic or bank failure reduces the amount of financial intermediation undertaken by banks, and leads to a decrease in investments and economic activity in general.

Unanticipated decline in price level: Unanticipated decline of prices reduces the firm´s net worth in the same way as stock market declines. Debts and credits are usually fixed in nominal terms, therefore when prices decline, the burden of a firm´s debt increases instantly. A sharp drop in price levels causes a decline in the firm´s net worth and an increase in asymmetric information and moral hazard.

No doubt, that the topic of financial crisis and its triggers belong to the field of economy, but in order to really understand such crisis researchers need to use knowledge and theories of psychology. Therefore, in the next section of this work I would like to demonstrate the role of psychology in studying economic crisis.

1.3. What happened in 2008? – How Psychology Drives the Economy

Since August 2007, financial markets and the global economy have been hit by shattering developments, which were caused by mortgage crisis in the United States. Major Banks and financial institutions made negative balances in billions of dollars and Euros (Hellwig, 2008). But how could this all happen so fast? Why did experts not notice and anticipate the collapse of banks, the loss of jobs and the severity of the recession? According to Akerlof and Shiller (2009), the answer to these questions is very simple. Economists, governments and the general public had been simply reassured by an economic theory that said “we were all safe” and that nothing dangerous can happen anymore. But obviously this theory was deficient. It ignored the importance of psychology and the role of ideas in the conduct of economy. Traditional economy assumes that people think rationally and that they pursue their economic interests in a reasoned way. But it does not consider the extent to which people act irrationally and are driven by noneconomic motives, the so called “animal spirits”.

The term animal spirit comes from the Latin expression “spiritus animalis” and refers to a basic mental energy. In economics the term has a somewhat different meaning; it describes a restless and inconsistent element in economy. The events of the current economic crisis cannot be explained without taking animal spirits into an account (Akerlof & Shiller 2009). Therefore, in the subsequent sections I would like to summarize the events that lead to the economic collapse by illustrating the role of animal spirits in each of these situations.

1.3.1. Animal Spirit 1. : Confidence and its Multipliers

According to the dictionary confidence refers to a “feeling or consciousness of one's powers or of reliance on one's circumstances” or a “belief that one will act in a right, proper, or effective way” (Merriam- Webster Online Dictionary). Economists have a very peculiar interpretation of confidence. Confidence is closely related to trust and belief. Their views suggest that both confidence and trust are completely rational. But the very meaning of trust is that it goes beyond rationality (Akerlof & Shiller, 2009). Trust is social and relational, rather than rational and calculative. Trust is based on a judgment of similarity between two persons, and an assumption that the person to be trusted would act as the trusting person would (Earle, 2009). The notion of confidence and trust play a major role in economics, and are often used as synonyms (Tonkiss, 2009). Both trust and confidence influence the economy directly, because when customers feel confident they are more willing to spend their money, when confidence drops they start withdrawing their money (Akerlof & Shiller, 2009). Thus, it is possible in principle that a loss of confidence in a country can produce an economic crisis, since people stop spending and investing in the economy (Krugman, 1998).

The notion of confidence in financial markets is not a modern economic phenomenon. The term “state of confidence” was first introduced by Keynes in his General Theory and became a key factor in his investment theory. In this work, Keynes concluded that a collapse in the confidence of either borrowers or lenders was sufficient to induce a downturn or a recession. However a return to wealth required that both be in good repair (Gertler, 1988). The General Theory of Keynes was written in the 1940´s, but its principles can be applied in modern economies as well. Loss of confidence by investors and the public in the strength of key financial institutions and markets is still the major root of financial crisis and recessions. The 2008 financial crisis is no exception (Tonkiss, 2009). Like many other recessions, the 2008 crisis also began with a loss of confidence in the ability of the banking, which caused credit markets to freeze up (Dahl, 2009). When banks lack solid information about the value of other banks’ assets and liabilities, they lack a basis on which to make rational decisions about lending. On the other hand, in the absence of reliable information, they cannot have confidence that the borrower will ever be in a position to repay the loan. Thus, if banks suspect that their partners conceal or lye about their capital reserves or asset values, then a failure of confidence is unavoidable (Tonkiss, 2009).

As the financial news started to report about negative developments of economic activity, the confidence of the people started dropping (Chorafas, 2008). Banks were taking on huge risks, which lead to an increased exposure to serious financial problems. When people eventually started to see problems, confidence fell quickly. As a result, lending slowed, in some cases it even ceased for a while (Shah, 2009). The S&P homebuilding index dropped from nearly 1300 in January 2007 to a miserable number of 700 a month later. Already by June 2007 US homebuilders’ confidence had fallen from 75% to only 25% percent. Lennar Corp., the biggest US homebuilder, reported a 73% drop in first quarter 2007 profit, with no improvement in the second quarter, while other homebuilders faced similar or even bigger losses. Bankers, however, paid no attention to these facts. Rather than that, they focused on rate cuts by the Fed and not on the risk of falling house prices (Chorafas, 2008). Investment banks were sitting on the riskiest loans that other investors did not want. Assets were falling in value, so lenders wanted to take their money back. But the investment banks had little in deposits; therefore they collapsed quickly (Shah, 2009). Excessive debt in the banking system has been transferred to governments in an attempt to bail out the banks and restart the system. Even though governments managed to save some of the bankrupted banks, they were not able to solve the problem of the confidence loss. Actually they made the problem even worse. The loss of confidence was transferred to governments as well, since people started to doubt the ability of the governments to repay these enormous debts (Dahl, 2009). This was confirmed in a survey conducted by the Center for European Policy Studies (Roth, 2009). The data show an extreme fall of confidence in the European Central Bank during the first months of 2009. Compared to 2008, tremendous falls of confidence were measured, with eight EU countries experiencing a decrease in net trust by over 30%. The trust in the European Commission as well the European Parliament also decreased dramatically during the aftermath of the financial crisis, suggesting a transfer of the confidence loss from banks to governments.

1.3.2. Animal Spirit 2: Fairness

In economic models and theories human actors are typically portrayed as "self-interest seeking with guile (which) includes . . . more blatant forms, such as lying, stealing, and cheating . . . (but) more often involves subtle forms of deceit" (Williamson, 1985, as cited in Fehr & Gächter, 2000, p.159). However, in reality many people deviate from purely self-interested behavior and act in a reciprocal manner. Reciprocity means that in response to kind actions, people frequently act much nicer and more cooperative than predicted by the self-interest model. On the other hand, in response to hostile actions they often act against the principals of rationalism, by being crueler or more brutal, than expected. Acting in a self-interested and profit-maximizing manner is for surely advantageous for an individual, but in repeated interactions the expectations of future returns provide a more positive gain, than the short term incentives of cheating. Therefore, acting according to the rules of reciprocity or “reciprocal fairness” pays off more on a long run (Fehr & Gächter, 2000).

Reciprocally fair people respond to friendly actions in a friendly manner, but in response to hostile actions they are willing to sacrifice resources in order to punish those who are being unkind (Rabin ,1993).Situations from everyday life provide reassuring examples indicating that people act according to principals of reciprocity and fairness more often than those of self-interest models. Well known examples are that many people pay their taxes honestly, always buy a bus ticket, get involved in charities or help a team member without asking any rewards in return (Fehr & Schmidt, 1999).

Although a large body of psychological research already demonstrated the inevitable role of fairness in economic interactions, it is still being pushed into a back channel of economic theories. But if one really wishes to understand economy, one must look at its sinister side, ruled by a lack of fairness, corruption and bad faith. In fact, most economic fluctuations and recessions can be traced to an outright of corruption and prevalence of bad faith. Each of the past economic recessions such as the recession of July 1990 to March 1991, the recession of 2001 and 2008 involved corruption scandals. The recession of 2008 was no exception. It is attributed to the mortgage scandals in the United States of America, which were partly caused by corruption and bad faith. Between 1990 and 2006 U.S. housing prices rose, and were followed by a massive increases in subprime lending from 5% to 20% (see Akerlof & Shiller, 2009). According to the publication of Inside Mortgage Finance, subprime home loan market peaked in 2005. In fact, between 2005 and 2007 lenders and mortgage brokers handed out $625 billion in mortgages to borrowers with low credit scores (Gandel, 2010). The subprime lenders became a major new industry, but this new business form was not properly regulated. Mortgages were pooled with other mortgages; the pools were divided, and marketed worldwide as bonds to banks, pension funds, insurance companies, hedge funds, and other entities generally known as “investors.” No one really knew, or bothered to know, how much risk was embedded in these investments and how this exposure could be managed (Chorafas, 2009). Subprime lenders issued mortgages that were unsuitable for their borrowers. They advertised their low monthly payments, but concealed the extremely high interest rates. Unfortunately, they were successful in placing these loans among the most vulnerable people; those who were the least educated and informed. These lenders did not believe in their own products, and they wanted to get rid of them as soon as possible. Thus, mortgages were sold as quickly as possible, and repacked in various different ways. Once these high-risk mortgages were put into more attractive packages, they were usually taken to rating agencies that had to put their approval on them. The agencies rated these subprime mortgages very highly; the ratings were in fact so high that they were brought into bank holding companies, insurance companies and often even into depositary banks, which would never have touched any of these mortgages on their own (see Akerlof & Shiller, 2009). Additionally, supervisory authorities did not react when the same shaky mortgages were repackaged ten to thirty times over and sold on. The Federal Reserve, the Securities and Exchange Commission (SEC), and other regulators watched this happening in the false belief that markets correct their own excesses (Chorafas, 2009).

As already mentioned, economic crisis and recessions are usually accompanied with fraud scandals, which are blatant examples of lack of fairness and bad faith. But none of the previous fraud scandals was as large and shocking as the real estate fraud committed by Bernard L. Madoff industry. Bernard L. Madoff started his carrier as a lifeguard on the beaches of Long Island, but eventually he built a trading powerhouse that had prospered for more than four decades, and brought him a lot of money. At age 70, he had become an influential spokesman for the traders and a well known broker in the real-estate market. However, on December 11, 2008, Madoff was arrested at his Manhattan home by federal agents and charged in what could be the largest fraud in Wall Street history. Madoff managed his funds by providing little information to investors but he demanded a lot of trust (Haughney, 2008). He was charged with fraud in the amount of $65 billion, but he pleaded guilty to all the federal charges filed against him, and on June 29 he was sentenced by a federal judge to the maximum prison termof 150 years (Washington, 2010). But it was not only Madoff who earned millions by fraud, much of the financial services industry has been quite similarly corrupted. The financial services industry has claimed an ever-growing share of the nation’s income, making the people who run the industry very rich. Yet, the financial services industry has been destroying value, rather than creating it. The wealth achieved by those who managed other people’s money had a corrupting effect on our society as a whole. In 2007 the average salary of employees in securities, commodity contracts, and investments was more than four times the average salary in the rest of the economy. Incomes of million dollars were fairly common, while wages of ordinary workers stagnated (Krugman, 2008).

1.3.3. Animal Spirit 3: Money Illusion

Money illusion is another animal spirit which implies a lack of rationality in economy. The term money illusion refers to a tendency to think in terms of nominal rather than real monetary values. For example, effects of past nominal values on current purchase or sale decisions represent a form of money illusion. This could manifest itself in a reluctance to sell a house or shares of stock at a nominal loss, or in a reluctance to accept nominal wage cuts (Shafir, Diamond & Tversky, 1997). Shiller & Akerlhof (2009, p.49) use a personal experience to illustrate the problem of money illusion. During a trip on a Boston commuter train, one of the authors saw a sign stating the following: “No Smoking- General Laws Chapter 272, Sec. 43A-Punishable by imprisonment for not more than 10 days or a fine of not more than $50 or both.” The denoted penalty for smoking is rather odd because a $50 dollar fine seems minimal in comparison to 10 days of imprisonment. No wonder that these fines seem completely incommensurable today, given that the law about non-smoking on trains was issued in 1968. But since then the value of the fine declined by 80%. In 1968, at 5 dollar per day rate seemed as a pretty reasonable cost of avoiding jail, but today it is laughable. Thus, the sign illustrates a typical example of money illusion, which occurs when decisions are influenced by nominal currency amounts.

Despite its prevalence in people´s decisions’, money illusion has largely been ignored by economists until the 1970's. Shafin et al. (1997) provide a psychological foundation for money illusion based on their analysis of survey data. They argue that although people are generally aware of the difference between real and nominal values, they still often think of transactions predominantly in nominal terms since, compared to real quantities, the nominal quantities are much more salient. Fehr and Tyran (2001) demonstrated this in a series of experiments. Their results showed that money illusion aroused only when payoffs were presented in nominal terms to the participants, that is, when nominal terms are more salient.

Money illusion played an important role in emergence of the 2008 crisis, mostly because the housing market is particularly prone to it. Housing price changes are often unpredictable due to the inefficiency in the housing market itself. Other than that, frictions such as short-sale constraints make it difficult for professional investors to anticipate possible mispricings. The bias caused by money illusion became evident in the 2008 financial crisis as well. In the recent years housing prices have reached unprecedented heights in the U.S. as well as in most European and Scandinavian counties (Brunnermeier & Julliard, 2008). Economist Robert Shiller (2007) referred to the increases in housing values during this time as the “biggest national boom in history” (Glynn, Lunney & Huge, 2009, p.807) First talks of a “housing bubble” began to surface in 2002, yet, even as some began to worry about the increases in house prices, the market continued to grow. Frictions such as short-sale constraints made it difficult for professional investors to anticipate possible mispricings. Before 2008, the inflation was relatively low for a longer period of time; therefore monthly nominal interest payments on mortgages seemed low compared to the rent of a similar house. Housing prices therefore appeared to be cheaper, causing “naive” buyers to buy rather than rent. People simply based their decisions of whether to rent or buy a real estate on a comparison between monthly rent and monthly payment of a fixed nominal interest rate. They mistakenly assumed that real and nominal interest rates were going to move in a same pattern. Therefore, they wrongly attributed a decrease in inflation to a decline in the real interest rate and consequently underestimate the real cost of future mortgage payments (Brunnermeier & Julliard, 2008).

Combined together all of the previously described factors caused tremendous economic problems all over the world. Bail outs from governments helped to overcome the crisis and people were assured that the crisis is over. But it seems that the problems were not really fixed, since just a couple of months ago Greece declared bankruptcy, and countries like Spain and Portugal might have to do the same (Inman & Smith, 2010) The economy became very unstable all over the world, thus there is an emerging need to study people´s behavior and feelings during turbulent economic times.


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Motivation during the financial crisis
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Mag. B.Sc. Tijana Gonja (Author), 2011, Motivation during the financial crisis, Munich, GRIN Verlag,


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