Philo eco blog: Keynes and Uncertainty (or a walk down memory lane to recover wisdom)

"We have, as a rule, only the vaguest idea of any but the most direct consequences of our acts." J.M. Keynes, 1937, 213. (I thank David M. Levy for calling my attention to this piece; see also Craig Friedland's (2008) Chicago Fundamentalism, Singapore.)

Not so long ago, Paul Krugman declared that the Keynesian moment had arrived. It did not happen. President Obama may regret his pragmatic (and disastrous) choice for the corrupt and overrated Larry Summers (rather than Krugman) as director of the White House National Economic Council. But even outside the US, Keynesian policies have not been pursued to the extent advocated by Krugman. (With several years of easy money and large budget deficits there HAS been considerable stimulus, of course!) This suggest we're dealing with more than parochial political balance(s) of power and lack of leadership.  It is worth asking why the Keynesian moment did not arrive (yet). For once I am disinclined to blame a corporate conspiracy (if only because corporations have always appreciated the benefits of Keynesianism.) The obvious answer is that stagflation of the 1970s thoroughly discredited Keynesian views among pragmatic economists--that is, the sort that become advisors to Presidents and prime ministers.

Keynesianism became a technocratic ideology for social engineers to fine-tune the economy.  Stagflation fatally undermined belief in fine-tuning (except at Central Banks, of course, where in the thrall of Milton Friedman's alternative approach to social engineering, they thought that they could manage the money supply and deliver low inflation, moderate growth, and never ending stock market gains--we know where that ended). But as my quote above already suggests, Keynesianism is no Keynes. We can identify three important aspects of Keynes' thought that were lost by his followers (including Krugman, who is too much a student of Samuelson).

First,  Keynesianism was part of an autonomous economic science (even going so far as to glorify its unrealistic psychological assumptions). But Keynes explicitly made social psychology the foundation of his economic theory; he calls it "fundamental" (see pp. 219-220 of the linked article, and also its conclusion).  Yet, Keynesian economic research never bothered to develop an active research program in economic social psychology.

Second, in my weekly posts I have regularly been exploring economics as a policy science in the face of uncertainty--one in which agents do not have same modalities governing their expectations. I have been inspired by the intellectual god-father of Chicago economics, Frank Knight, who pioneered uncertainty in economics. Yet, the greatest theorist of uncertainty may well have been Keynes. I quote again from Keynes' response to Viner:

"By, uncertain knowledge,let me explain, I do not mean merely to distinguish what is known for certain what is only probable. The game of roulette is not subject, in this sense, to uncertainty; nor is the prospect of a Victory bond being drawn. Or, again, the expectation of life is only slightly uncertain. Even the weather is only moderately uncertain. The sense in which I am using the term is that in which the prospect of a European war is uncertain, or the price of copper and the rate of interest twenty years hence, or the obsolescence of a new invention, or the position of private wealth owners in the social system in 1970. About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know. Nevertheless, the necessity for action and for decision compels us as practical men to do our best to overlook this awkward fact and to behave exactly as we should if we had behind us a good Benthamite calculation of a series of prospective advantages
and disadvantages, each multiplied by its appropriate probability, waiting to be summed." (Keynes, 1937, 213-214)

Now, as far as I can tell Keynes nor Knight seemed to have appreciated each other's interest in uncertainty. In the post-war years, Knight became associated with uncertainty, and his views were sent to the dustbin of history by the sophistry that uncertainty is identical to randomness hidden under the technical, mathematical wizardry of Samuelson and Arrow.  Perhaps because Keynes was identified with objective (Frequentist) account of probability, folk missed that he contrasted it with uncertainty. His self-proclaimed followers marched confidently to the halls of power ignoring his self-understanding in a third respect.

For, Keynes was adamant that his policy cures were restricted in scope: "I consider that my suggestions for a cure, which, avowedly, are not worked out completely, are on a different plane from the diagnosis. They are not meant to be definitive; they are subject to all sorts of special assumptions and are necessarily related to the particular conditions of the time." (221-222)

With a Nuclear disaster unfolding in Japan, Europe's currency (and, thus, political) union imperiled, US fiscal increasingly irrational, and inflationary pressures causing havoc and revolutions in poor countries around the world, we may still find ourselves in dire straits. If so, we may have to turn to a more authentic follower of Keynes. One that values cultivated judgment, intellectual curiosity, and moral leadership. Keynes was steeped in classics, history, mathematics, literature, and philosophy, not to mention the son of one of the greatest methodologists in the history of economics. Of course, our technocratic education of economists makes it unlikely that we can expect much leadership from them. As I have recounted (here, here, here), many of the world's leading policy economists betray a remarkable ignorance of matters of fundamental significance to their own discipline.