Uncertainty and Rationality: Keynes and Modern Economics
John Allen Kregel and Eric Nasica
Changing views about the future in a monetary economy
The intellectual revolution triggered by Keynes's General Theory of Employment, Interest and Money (1973c ; hereafter GT) is often described as a shift in emphasis from microeconomics to macroeconomics, and as a shift from study of optimal behaviour of the individual consumer or the individual firm to study of broad statistical aggregates, such as income and employment, or consumption and investment. For a long time macroeconomists thought it unnecessary to provide a special explanation of individual behaviour, but eventually traditional microeconomics was introduced into the Keynesian model to provide 'micro foundations' to explain individual decision making. However, Keynes never used the term 'macroeconomics', and it soon became obvious that there was an inherent tension between the traditional approach to optimal individual behaviour and the Keynesian explanation of the movements of income and employment.
Keynes in GT drew a distinction between analysis of an economy 'subject to change, but where all things are foreseen from the beginning' and 'the problems of the real world in which our previous expectations are liable to disappointment and expectations concerning the future affect what we do to-day' (GT, pp. 293-4; emphasis added). In the preface to the book he had already emphasized that his intention was to analyse 'A monetary economy' which he defined as 'one in which changing views about the future are capable of influencing the quantity of employment and not merely its direction'. He went on to add that this would require a 'method of analysing the economic behaviour of the present under the influence of changing ideas about the future' which was more general than the method employed by traditional theory (GT, p. vii).
Far from ignoring the problems of explaining the behaviour of economic agents, Keynes calls for a more general explanation of behaviour in more realistic conditions. He thus sought to substitute the assumptions of traditional theory that 'all things are foreseen from the beginning' with a theory of behaviour based on the assumption that 'previous expectations are liable to disappointment and expectations concerning the future affect what we do to-day' (GT, p. vii). The traditional view of Keynes's theory as 'macroeconomics' rather than the theory of a 'monetary economy', has thus quite naturally overlooked what it did not expect to be there, but which Keynes considered to be the very heart of his approach, namely, a theory of individual behaviour.
The aim of this chapter is to spell out Keynes's ideas on this subject in more detail, pointing to the crucial influence of his earlier Treatise on Probability (1973a ; hereafter TP) on the views expressed in the General Theory. Although economists who had written before Keynes had not ignored the analysis of the behaviour of economic agents, he felt that they had not adequately analysed the implications of a changing, unknown future. Yet most economists who have written after Keynes have ignored his suggestions for a more general approach. Section 11.2 investigates the essential differences, drawing on the recent contributions of a number of Post-Keynesian economists. Section 11.3 builds on this discussion to show how those extensions of Keynes's approach provide the basis for a criticism of the traditional definition of economic 'rationality', as well as providing the foundation for an alternative approach to the analysis of rational economic behaviour.