Pigou

Pigou is one of the Cambridge economists least known for using psychology within economic theory. Even so, he did posit the idea that industrial fluctuations could be generated by errors of undue optimism and pessimism, and within this approach were found both explicit and implicit psychological projections.

For Pigou, industrial fluctuations were caused by a ‘psychological reflux from the actual experience of good and bad fortune, good fortune breeding errors of optimism, bad fortune errors of pessimism’ (Pigou 1927 [1967]: 73). Business events such as good and bad harvests, technological inventions, mineral discoveries, industrial disputes, and so on all had associated psychological impacts. But the main cause of errors of optimism or pessimism was that the economy was not stationary, nor did it move in a continuous line, rather ‘productivity and desire move in jerks’ (ibid.: 74).

Pigou linked this discontinuity with a potential for mental miscalculation. Forecasting errors occurred whenever a linear path for future growth was assumed, or when changes in evolving psychology were assumed to be continuous. In fact, movements in the economy and business psychology were discontinuous, the latter exhibiting a form of ‘psychological interdependence’ that created herd behaviour via the spread of epidemics of confidence (ibid.: 86). As to the relative importance of psychological factors, Pigou judged that the optimistic or pessimistic error factor was ‘of the same order of magnitude as that of the monetary factor’ (ibid.: 220), or the influence of bank credit.

There is one important aspect of Pigou’s use of psychology which is less frequently emphasised but which is crucial to understanding how it was being employed. In a non-stationary state ‘peopled by perfectly intelligent persons psychological causes...could not exist, since they imply error’ (ibid.: 36). For Pigou, ‘psychological’ factors were inherently mistaken or illusory in nature to some degree, that is, a psychological influence necessarily provided a degree of distortion or a misrepresentation of reality, although not necessarily completely so. This approach can be seen in his analysis of ‘cumulative movements’ in the economy. He characterised ‘cumulation via psychology or expectations’ as ‘much more important’ than mechanical cumulation (Pigou 1941: 243) and showed that psychological projections were subject to over- or underestimation (‘less rosy glasses’) in response to the changing context.

Although there are no references to Cambridge psychologists in the Pigou works discussed here, his use of the idea of psychological error had a direct parallel in the work of Cambridge psychologists like Stout, who had written explicitly on the nature of error. For Stout, error occurred when what was merely apparent appeared to belong to an independent reality (Stout 1902 [1930]: 259), that is, it involved a form of mental confusion, inadvertence, or ignorance. Thinking of mere appearances was a way in which the presentation of unreal things could have real effects, just as, for Pigou, psychological errors in business could have real effects on the economy, despite being based on distorted premises.