Friday, November 18, 2011

Regime uncertainty is a weak explanation of the current depression... but that is NOT an excuse to fail to take regime uncertainty seriously

And Keynes agreed -

"This means, unfortunately, not only that slumps and depressions are exaggerated in degree, but that economic prosperity is excessively dependent on a political and social atmosphere which is congenial to the average business man. If the fear of a Labour Government or a New Deal depresses enterprise, this need not be the result either of a reasonable calculation or of a plot with political intent; — it is the mere consequence of upsetting the delicate balance of spontaneous optimism. In estimating the prospects of investment, we must have regard, therefore, to the nerves and hysteria and even the digestions and reactions to the weather of those upon whose spontaneous activity it largely depends.

We should not conclude from this that everything depends on waves of irrational psychology. On the contrary, the state of long-term expectation is often steady, and, even when it is not, the other factors exert their compensating effects. We are merely reminding ourselves that human decisions affecting the future, whether personal or political or economic, cannot depend on strict mathematical expectation, since the basis for making such calculations does not exist; and that it is our innate urge to activity which makes the wheels go round, our rational selves choosing between the alternatives as best we are able, calculating where we can, but often falling back for our motive on whim or sentiment or chance

- John Maynard Keynes, 1936 (Ch. 12, The General Theory of Employment, Interest, and Money)


  1. Apt citation of Keynes in Chapter 12 of the GT, Daniel.

    Chapter 12 is also one of the two references that Keynes makes to his 1921 mathematics book, "A Treatise on Probability". The second reference refers back to the footnote on Chapter 12, if I'm not wrong.

    Also, on a side-note, did you get my e-mail on Daniel Ellsberg? Can you please respond to it?

  2. Regime uncertainty is one of many cooperating factors. No one suggests economic growth is slow ONLY because business is scared. But too many people discount it entirely.

  3. Mattheus -

    Given - say - Paul Krugman's estimate of its significance in the Great Depression and today, and - say - Bob Higgs's estimate of its significance in the Great Depression and today, I would say that Krugman is much, much, much closer to the mark.

    I hope you found Keynes's reference to it interesting, though.

  4. Any other answer would surprise me, Daniel.

  5. If you have to accept rational expectations, then you can probably believe that business can estimate what the likely political atmosphere is going to be and change its practices in advance according to it.

    But of course, many of us would say (rightly) that rational expectations is not correct, because it is not psychologically realistic. I'd agree.

    However, make one small concession. The ability to predict people's behaviour is the barometer of usefulness of an economic theory, not its psychological realism. Wall Street yawned when the debt ceiling hysteria occurred and quietly continued to purchase more government bonds without paying attention to panicked cries of possible default. Why was that?

    Because the largest players in financial markets had pretty rational expectations of how politicians behave and what politicians are going to do. The fact that American financiers lost nothing by purchasing government bonds even during an allegedly uncertain period of deficit deal fiasco shows that



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