Problems of Uncertainty
Leon Walras
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Walras wanted to show evidence that free
markets provide the optimal allocation of prices
and factors by mathematical methods.
Beside non-realistic assumptions the model can
be rejected by „Goedeler's incompleteness
theorem“.
Uncertainty has no meaning in the Neoclassical
Model
Chapter 12: The State of
Long-Term Expectations
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Long term expectations are decisive for
investments.
Long term expectations are determined by
psychological factors.
The role of knowledge has an influence to the
“state of confidence”
The “state of confidence“ rules these factors.
The “state of confidence“ is also influenced by
conventions.
Conventions
“Worldly wisdom teaches that it is better for
reputation to fail conventionally than to
succeed unconventionally.“
(Keynes)
Conclusions of Chapter 12
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Uncertainty plays a major role for investments.
A lack of confidence leads to lower investments,
less effective demand and higher
unemployment rates.
The “state of confidence” has a higher impact
on investments than monetary policy.
Chapter 18: The General Theory of
Employment Re-stated
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Given factors
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Dependent variables
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Independent variables
Given factors
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Skill and quantity of available labor.
Existing quality and quantity of available
equipment.
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Existing technique
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Degree of competition
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Tastes and habits of the consumer
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Factors that determine the distribution of
national income...
Given factors
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These factors are not constant but Keynes
considers that these factors are not changing
over a period.
Independent variables
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The propensity to consume.
The schedule of the marginal efficiency of
capital.
The rate of interest.
Dependent variables
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Volume of employment.
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The national income.
Implications
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The given factors influence the independent
variables but do not completely determine them.
The schedule of the marginal efficiency of
capital is determined by the given factors, partly
of the prospective yield of capital-assets of
different kinds, whilst the rate of interest
depends partly on the state of liquidity
preference and partly by the quantity of money
measured in wage-units. (GT p. 157)
Independent variables
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Independent variables are consisting of three
parts:
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1. The psychological propensity to consume.
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2. The psychological attitude to liquidity.
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3. The psychological expectation of future yield
from capital assets.
Keynes's conclusion
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“ ...the physical conditions of supply in the
capital goods industry, the state of confidence
concerning the prospective yield, the
psychological attitude to liquidity and the
quantity of money … determine between them
the rate of new investment.“ (GT p. 157)
Conclusion of chapter 18
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New investments are highly influenced by
psychological factors in an uncertain world,
namely determined by the “state of confidence“.
Keynes's criticism on Tinbergen
- Tinbergen uses multiple linear correlations
without explanations for an economic model.
- The economic environment is not homogenous
over a period of time.
- A set of empirical statistical data of the past has
no meaning for statistical outcomes for the
future (non-ergodicity).
The relation between the „Treatise
on Probability“ (TP) and the „The
General Theory“ (GT)
- The TP was submitted in 1907/08 and published
in 1921.
- The GT was published in 1936.
- There is a strong belief in the PK school there
would be a deep link between the GT and the
TP.
Objective and subjective probability
- One fraction of the PK school (Continuists)
assumes that Keynes developed an objective
theory in the TP and let in unchanged until the
publication of the GT.
- The other fraction (Discontinuists) assumes that
Keynes first developed an objective theory of
probability and later changed to a subjective
theory due to the objections by Ramsey.
Uncertainty
- Both fractions assume that the definitions of risk
and uncertainty are similar by Keynes and
Knight.
- According to Keynes and Knight risk is defined
as a quantifiable risk and uncertainty as a nonquantifiable risk.
- So, according to Ramsey, non-quantifiable risks
can be quantified by betting quotes.
Uncertainty
- Both fractions do not consider the decisive
question that there is a difference between
Knight's and Keynes's definition of uncertainty.
- According to Knight uncertainty can be
quantified by computational methods.
- According to Keynes uncertainty can never be
reduced to a quantifiable risk.
Missing the point of Keynes
- The whole discussion in the PK School is a
shadow boxing based on the hypothetical
assumption that there would be a connection
between the TP an the GT.
- The discussion misses the point that Keynes
outlined uncertainty as a non-quantifiable risk
which cannot be quantified by any methods.
- The discussion misses also the point that any
statistical data from a time series of the past has
no meaning for future events.
Conclusion
- The whole discussion is symptomatic for the
current PK School.
- Theoretical discussions which have no meaning
for Keynes at all and no meaning for the
economic world of today.
- The GT was an answer to the Great Depression.
- The task of the PK School should be to adjust
the GT to the economic world of today.