Chapter 6. The Role of Expectations
Chapter 5 of the General Theory, Expectation as Determining Output and Employment, is in the main both sensible and realistic.
Keynes begins by pointing out what ought to be obvious.
All production is for the purpose of ultimately satisfying a consumer.
Time usually elapses, however, and sometimes much time,
between the incurring of costs by the producer with the consumer in view
and the purchase of the output by the ultimate consumer.
Meanwhile, the entrepreneur has to form the best expectations he can,
And he has no choice but to be guided by these expectations, if he is to produce at all by the processes which occupy time.
Keynes then goes on to distinguish short-term expectations, concerned with current production, from long-term expectations, concerned with additions to capital equipment.
After introducing many needless elaborations and complications, he concludes,
for the Previous Change has fully worked itself out, page 50.
There would be little need to devote much attention to this chapter if Keynes's admirers
and disciples had not made so much adieu about it.
Expectations, writes Alvin H. Hansen, commonly regarded as Keynes's leading American disciple,
play a role in all Keynes's basic functional relations.
The British economist J.R. Hicks hails this as a new and vitally significant element.
Once the missing element, anticipation, is added, equilibrium analysis can be used not
only in the remote stationary conditions to which many economists have found themselves
Such a statement makes a reader rub his eyes in incredulity.
It may be true that it has only recently become fashionable for academic economists to lay
a great deal of emphasis on expectations under that specific name.
But most economists since Adam Smith's day have taken them into account if only by implication.
No one could ever have written about the fluctuations in the stock market or in the price of wheat
or corn or cotton without doing so at least implicitly in terms of the expectations of
speculators, investors and the business community.
And most writers on the business cycle have recognized the role that changes of expectations
play in booms, panics and depressions.
It was the practice of the older writers to introduce this element under the names of
optimism and pessimism, or confidence and lack of confidence.
Thus, to cite only a single example, Wesley C. Mitchell, as early as 1913, wrote,
are among the conclusions at which it arrives. This fact gives hopeful or despondent moods a large share in shaping business decisions.
Even if academic economists had entirely neglected the role of expectations in economic changes,
Every speculator, investor and businessman must, from time immemorial, have been aware of the central role that expectations play.
Every sophisticated speculator knows that the level of prices on the stock market reflects the composite expectations of the speculative investment and business communities.
His own purchases or short sales are in effect a wager that his own expectations about future security prices are better than the composite current expectations against which he bets.
Every investor and businessman is inescapably in part a speculator.
The businessman not only has to calculate what consumers will be willing to pay for his product when it is ready for the market, he also has to guess correctly whether they are going to want that product at all.
The chief criticism to be made of Keynes's treatment of expectations, in chapter 5, is not that it gives them too much emphasis but too little.
For that chapter is concerned with the effect of expectations merely on output and employment.
Keynes should have recognized also that expectations are embodied and reflected in every price,
including the price of the raw materials that the individual businessman has to buy and the wage rates that he has to pay.
One further observation, however, must be made on Chapter 5 of the General Theory.
Throughout it, Keynes makes the tacit but never explicit assumption that there is nearly always substantial unemployment.
Unemployment. He assumes that when new workers are demanded in the capital equipment industries,
for example, they are always added to the total volume of employment. They are apparently
drawn out of some unspecified army of unemployed. Keynes never considers the possibility that
The new capital goods workers might have to be recruited from existing consumer goods workers.
He never considers what the effect of this competition for workers might be on raising wage rates rather than merely increasing the volume of employment.
Wage rates are tacitly assumed to remain unchanged.
The limitations and nature of Keynes's assumptions, in short, make his theory of employment at best a special theory, not a general theory, as his title boasts.