ADAPTATION LEVEL AND ANIMAL SPIRITS

In the tradition of physiological psychology dating back to Wilhelm Wu ndt, an adaptation-level approach is taken to the level of economic ce rtainty, as measured by the psychologically sensitive unemployment ser ies. Unemployment levels 'low' relative to the adaptation level are sh own to promote confidence - high 'animal spirits' - while the converse holds for 'high' unemployment rates. The resulting metric is shown to play a major role in confidence level formation and output determinat ion, standing in causal relation to survey measures of consumer and pr oducer confidence as well as industrial production, in a reasonably st able manner. Recessions tend to coincide with periods of low trailing volatility of the unemployment rate as agents become 'sensitized' to b ad news. The paper also considers the issue of a preference for variet y over the business cycle, in the spirit of the spontaneous alternatio n experiments in psychology which show such a preference in a multitud e of settings. It is suggested that attempts to smooth the business cy cle may become counterproductive (to the extent that such policy can b e considered exogenous) if they produce less than 'optimal' levels of 'variety', construed in this context as alternation of confidence leve ls. The literature on subjective novelty surveyed by Scitovsky (1976) suggests that 'utility maximizing' and 'optimal' or productivity maxim izing levels of variety may be different things, as agents tend to do well on a variety of cognitive tasks on the descending outer portion o f the Wundt parabola, at levels of arousal beyond utility maximization . A bracing business cycle may be adaptive. Suggestions for further re search include relating the current findings to self-organized critica lity, and further study of the interworkings of adaptation level and v olatility over the business cycle.