Jonathan on Keynesian Uncertainty

Jonathan makes some excellent point on Keynesianism, the Austrian school, and uncertainty here. I don't know why some people feel this need to make things up about the other side to make them appear completely naive to less knowledgeable readers. It's not a way to raise the discussion to a higher level.

I think the best and most obvious way to put it is that uncertainty and expectations have been a critical part of both the Keynesian and Austrian visions. Uncertainty has probably been more central to Keynesians longer. It's the core of Keynes - and he contributed, along with Frank Knight, our most sophisticated understanding of uncertainty, as opposed to risk*. Both of these men wrote a lot about how uncertainty was critical for understanding the role of the entrepreneur in the economy. This concern for uncertainty continued implicitly and explicitly through other Keynesians. I think you saw uncertainty enter the Austrian discussion somewhat later with Lachmann, Kirzner, Higgs, and Rothbard (I'm happy to be corrected - I just never hear people citing earlier work on Austrian uncertainty the way they cite Keynes).

As Jonathan points out, concern with expectations has been there from the beginning for both. I think I've noted before that in this sense New Keynesianism is really coming back to the Keynesian core by emphasizing things that the "Old Keynesianism" that came from Hicks and Samuelson glossed over. Part of this is just modeling sophistication. Hicks made a tremendous contribution. We can't expect him to formalize everything in the General Theory. Uncertainty, of course, is notoriously hard to model for reasons that Jeff Friedman outlined in a recent Critical Review article. I disagree with Friedman on the point of whether economists who work with search and risk models ignore these points. I don't think they do at all. But he's right on the modeling difficulties.

So that's a lay of the land on uncertainty and expectations I think. You would be safe to steeply discount anyone who says this isn't central to the way Keynesians think. You also ought to steeply discount anyone who says that of Austrians.

That's not very salacious blogging, I know. "We both think X but we may emphasize somewhat different things about it" is a lot less exciting than "they don't pay attention to X and that's why they're awful". It's less interesting blogging to some people, but it is... you know... accurate.

Jonathan notes:

"Whether or not these economists are talking about uncertainty in their blogs and op-eds is irrelevant, because uncertainty is implicit in their models.  Consider, for instance, Paul Krugman’s work on Japan (“It’s Baaack,” Brookings Papers on Economic Activity 1998, 2 [1998]): expectations, and thus uncertainty, is a major factor behind the advocacy for high inflation targeting.  That they target different causal factors doesn’t make it any less of a use of uncertainty."

I agree with this. A lot of the understanding of uncertainty is implicit. Uncertainty is a big part of why financial crises reduce demand. It's not just an income effect (although the income effect matters too!). Sometimes both of these are subsumed and people just observe that financial crises cause large demand shocks. So I think Jonathan is right that even if we don't see this stuff in blog posts, that doesn't mean it's not there. But as the last four Keynesian Uncertainty posts of mine pointed out - it's in the blog posts, spelled out very clearly! I'm also glad he linked to Krugman's Japan paper, because despite any claims by Krugman to the contrary, he's not just a hydraulic, circular flow Keynesian - and the Japan paper proves that. It discusses uncertainty and long-run expectations on a more sophisticated level than you'll see most Post-Keynesians discussing the issue, certainly.

Jonathan ends with this, and I am intrigued to hear more: "So, when discussing on what causes the differences in policy advocacy between Austrians and the rest, the real answer ought to target the decades (almost a century now) of divergence in understanding of the market process."

Maybe. I'm not quite convinced that's the real difference. I keep hearing that Austrians have a sophisticated understanding of the "market process" that nobody else shares but I've never in my life heard an Austrian say something about the market process that isn't agreed to by most economists (including, of course, Keynesians). Sometimes Austrians may like to provide verbal expositions and they think that the modeling of others is unsophisticated. Sometimes the feeling is mutual, even. Different styles emphasize different things. But I have yet to come across an explanation of the market process or exchange relations from an Austrian that goes beyond emphasizing something I might not talk about as much and actually clashes with my view of thing.

So I'm doubtful. This stuff often veers into that "I'll tell you your position, which I will then proceed disagree with" territory that really bugs me.

I think the differences are a lot less exciting than that. First, we emphasize different processes. Austrians talk a lot about the impact of macro phenomena on the capital structure - an issue Keynesians often ignore in the name of parsimony. Keynesians discuss why liquidity preference implies that the economy is demand-constrained, and that the interest rate is not just the price of loanable funds. Divergences between the interest rate implied by a clearing loanable funds market and one satisfying demand for liquidity can generate swings in economic activity. Austrians often ignore these issues, less in the name of parsimony (because there is less formal modeling among Austrians), and more as a result of the way they think about credit markets. There's nothing "anti-Keynesian" about talking about the capital structure (in fact Keynes agrees with Bohm-Bawerk's capital theory in the General Theory, he just says it's inconsequential for the macroeconomy). Likewise there's nothing "anti-Austrian" about talking about liquidity preference (see Bob Murphy). They just ended up talking about different things.

I think the directions they each took Wicksell is key to understanding the difference between Austrians and Keynesians. You will hear internet Austrians say that Keynes didn't understand Wicksell. Ignore them. They are barking up the wrong tree and probably doing it because they have a chip on their shoulder about Keynesians. Hayek added Cantillon and Ricardo and Bohm-Bawerk to Wicksell and came up with a theory that emphasized certain processes. Keynes added Jevons and Marshall and Malthus to Wicksell and came up with a theory that emphasized certain process. Which Wicksell would have preferred isn't knowable because the man was dead by then. I'd bet he would have liked both.

The point is, pretending that the difference between Austrians and Keynesians as being (1.) political (e.g. - Keynesians are statists and Austrians are the ones that appreciate liberty), (2.) a differential appreciation of something that both demonstrably have an appreciation for (e.g. uncertainty), (3.) a somewhat different way of talking about something we all agree on (e.g., the market process) is all wrong.

The difference, really, is that human economic and social behavior is tremendously complex and there are a lot of processes at work. No one can talk about all of them. Austrians and Keynesians talk about slightly different processes (with at least one common antecedent: Wicksell). There are two questions: (1.) does their theory make sense (in most versions of Austrian and Keynesian economics I think the answer is more or less "yes"), and (2.) is their theory empirically important (I tend to think the Keynesian answer wins out on this one)?

* - This is another example of "making things up" that people do. Some people will only cite Knight on this development and act like Keynesians are clueless or don't understand the role of entrepreneurship and profits. Why? They published their most substantial contributions in the same year. They're both famous books and most people cite them together. The only reasons are genuine ignorance (which is easily corrected) or pettiness (which is less easily corrected).