Keynes’s General Theory, chapter five

by on December 15, 2008 at 7:22 am in Books, Economics | Permalink

Part i shows that Keynes had digested the Austrians, and especially the Swedes, far more than he let on.  He goes through considerable machinations to show that his main argument is consistent with the Swedish long vs. short-run, ex ante vs. ex post analysis that ruled Stockholm at the time, as found in Myrdal, Lindahl, Ohlin and others.  For all of Keynes’s periodic dismissiveness of his precursors, I read him as actually quite intimidated by them.  In this section he’s "looking for their approval," if only in his own mind.

In Part ii Keynes presents two bombshells, more or less from out of nowhere:

a) For the short-run, the common default expectation is that "recently realized results will continue"; this precludes entrepreneurial creativity and creation as a way out of a bad situation.  You’ll note the influence of Cambridge epistemology here, namely that we do not recreate our entire basic picture of the world de novo every day.  G.L.S. Shackle is mostly a Keynesian but on this issue his emphasis on the creative imagination of the individual is a significant revision of Keynes.

b) Long-term expectations do not adjust smoothly but rather become more bullish or bearish in volatile leaps.

Furthermore a) and b) are held together, which implies at some margin a sharp disjunction between the short-run and long-run.  I do not regard Keynes’s two assumptions as absurd, but they are hardly a "general theory."  Note that you need a) to choke off various processes of recovery and you need b) to get investment demand to be so volatile in the first place.  Let’s say you think b) is reasonable, then in my view you should also believe in possible "cascade" effects which can pull you out of a downturn in the short run.  But for Keynes, no.

Here is a comment on last week’s session.  Chapter six will be going up this afternoon.  On short vs. long-term expectation, Felix Salmon has some good points.

1 Tim December 15, 2008 at 7:47 am

Given the statement in part ii that you reference in a), I was interested in the apparent relegation of entrepreneurs to post-manufacturing steps at the beginning of Chapter 5. In the first and second paragraphs of the chapter, he seems to place entrepreneurs purely in the post-manufacturing phase. He seems to be ignoring one of the roles of the entrepreneur that Schumpeter would identify, developing a new product or method of production.

With that view, wouldn’t the role of expectations in the manufacturing sector be limited to demand for what already exists, i.e. an economy that does not evolve or change?

2 matthew mueller December 15, 2008 at 11:44 am

I wrote a response to Cowen’s discussion of chapter 4 here:

http://post-austrianeconomics.blogspot.com/2008/12/tyler-cowen-on-keynes.html

Just some points here on chapter 5. Shackle used this chapter and its discussion of time to destroy the first postulate of classical economics (see the link above). Keynes, however, retained this postulate for reasons unrelated to the subject of expectations and time.

Also, I think it is important for readers to know here how Keynes distinguished “short term” expectations from “long term” ones. The former refers to the price the “manufacturer” of finished goods can get from entrepreneurs. Long term expectations, on the other hand, refers to the “uncertain” future returns entpreneurs expect to receive from their use. this is why “lonmg term” expectations are more difficult to forecast. Moreover, Paul Davidson’s discussion of the importance of “contracts” in my view makes the difficulties associated with short term expectations almost moot.

This may explain Professor Cowen’s confusion over the apparent “disjunction” between these two different expectations. Short term expectations are usually expressed via contracts, and Shackle concerned himself rightly only with the influence of long term expectations, which are quite different from short term ones.

3 Tyler Cowen December 15, 2008 at 2:35 pm

Hey people, don’t you care about Keynes?

4 Selfreferencing December 15, 2008 at 4:04 pm

I care, but the problem with Chapters 5 and 6 is that Keynes says that they aren’t essential to the General Theory in the introduction to Chapters 4 – 6. I think that’s maybe why people didn’t dig the idea. Also: lots of your readers are in school, so they’re very, very busy right now. End of the semester was perhaps not the best time to start a reading group.

It might be worthwhile to postpone Chapters 7 and 8 until after Christmas.

5 Barkley Rosser December 15, 2008 at 4:54 pm

Tyler,

More that your summary is pretty good, and the points
at issue here are not all that contentious or startling.
I largely agree with matthew mueller’s additional remarks.

The only other point to add as far as I am concerned is
simply to note that these distinctions are not all that
far from the traditional Marshallian ones, and for all his
dumping of Marshall in with “the classicals,” he remained at
heart, much like Milton Friedman, a good Marshallian. who he
knew personaly. Indeed, the Marshallian distinction ultimately
boils down to allowing capital to vary, which means the question
of capital investment. So, in the short run, capital is fixed
(along with nominal contracts), while in the longer run, the
“flighty bird” of capital investment comes into play, and the
determination of capital investment depends on expectations,
the deeper discussion of which comes in the absolutely central
Chapter 12.

6 Greg Ransom December 15, 2008 at 9:48 pm

Marshall’s economics is all about muddling together the modern, forward looking pure logic of microeconomic analysis together with old style, backward looking, non-microeconomically grounded Ricardian type aggregates. All this “short term” / “long term” stuff is part of the grope in the dark attempting to link up the purely logical reasoning of the microeconomics of choice with real world entrepreneurial activities and “empirical categories” in the real world.

Hayek’s critique of this muddle can be found in the first chapters of _The Pure Theory of Capital_, in some of his special papers on the nature of economic explanation and on capital theory (e.g. his reply to Knight), and elsewhere.

Part of Hayek’s rejection of Keynes is his rejection of this whole approach to economics — for Hayek it represented a regression to the least helpful parts of non-microeconomic, pre-modern economics.

“these distinctions are not all that
far from the traditional Marshallian ones, and for all his
dumping of Marshall in with “the classicals,” he remained at
heart, much like Milton Friedman, a good Marshallian.”

7 Current December 17, 2008 at 12:52 pm

I agree with Barklay Rosser and Greg Ransom.

Another basic mistake is worth noting, Tyler says: “this precludes entrepreneurial creativity and creation as a way out of a bad situation. You’ll note the influence of Cambridge epistemology here, namely that we do not recreate our entire basic picture of the world de novo every day.”

These are not very connected. Certainly we do not recreate our entire picture of the world every day. However, to be entrepreneurial does not require us to do so.

Any descent entrepreneur will have many plans for the future. Some of them he or she will employ, some will be left on the shelf. When a change in macroeconomic occurs new thinking is not necessarily even needed very much. It may simply be appropriate to dust of an old business plan and reuse it.

People may act like marginalistic robots and still get out of trouble.

8 online games May 10, 2009 at 1:53 am

Marshall’s economics is all about muddling together the modern, forward looking pure logic of microeconomic analysis together with old style, backward looking, non-microeconomically grounded Ricardian type aggregates.

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