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Abstract
We investigate how Keynes and Friedman, respectively, address the issue of the disequilibria at stake in a monetary economy through a shared concern for the formation of expectations. We show that Keynes was interested in the coordination of long-term expectations regarding non-monetary assets prospective yields, while Friedman focused on the adaptation of short-term nominal expectations. Regarding the remedies to these disequilibria, both economists called for devices that aim to stabilise market expectations. As a direct outcome, Keynes designed policies that aim to stabilise the long-term state of expectations while Friedman basically aimed at the acceleration of the competitive adjustment process.
Keywords:
Disclosure statement
No potential conflict of interest was reported by the author.
Notes
1 Successive versions of this paper were presented to the 2014 Charles Gide Conference in Lyon, the 2016 Charles Gide Conference in Strasbourg and to the 2016 HES Conference at Duke University. Over time, I benefited from the criticism and comments of many participants at those conferences. I am in particular indebted to Bob Dimand, Rodolphe Dos Santos Ferreira, James Forder, Nicola Giocoli, and George Tavlas. I am also extremely grateful to two anonymous referees. Nonetheless, the usual disclaimers apply.
2 See his interview given to Snowdon and Vane (Citation1999).
3 The economy to which Keynes refers here is not merely a barter economy. As noticed by Hahn (Citation1977: 38), “the idea that there would be no unemployment in a barter economy is grotesque”. To put it differently, the use of money is not mandatory in obtaining disequilibrium. In Hahn's words: “It is therefore not money which is required to do away with a Say's Law-like proposition that the supply of labour is the demand for goods produced by labour. Any non-reproducible asset will do. […] Keynes was fully aware of this and that is why he devoted so much space to the theory of choice amongst the alternative stores of value” (Hahn Citation1977: 31).
4 Keynes insisted that the same type of troubles might arise in an economy in which the factors of production, and crucially wage-earners, would be paid in anything other than the good they produce: “Money is par excellence the means of remuneration in an entrepreneur economy which lends itself to fluctuations in effective demand. But if employers were to remunerate theirs workers in terms of plots of land or obsolete postage stamps, the same difficulties could arise. Perhaps anything in terms of which the factors of production contract to be remunerated, which is not and cannot be a part of current output and is capable of being used otherwise than to purchase current output, is, in a sense, money. If so, but not otherwise, the use of money is a necessary condition for fluctuations in effective demand.” (Keynes [1933] CW 29: 86)
5 Keynes had already made this point himself in his Treatise on Probability: “Probability is not related to the balance between favourable and unfavourable evidence but to the balance between the absolute amount of relevant knowledge and of relevant ignorance. […] An accession to new evidence increases the weight of an argument. New evidence will sometimes decrease the probability of an argument, but it will always increase its ‘weight’ ” (Keynes [1921] CW 8: 77).
6 See Runde (Citation1994) and Roncaglia (Citation2009).
7 But the case of short-term mismatches of expectations is well taken into account in Keynes’ Treatise on Money.
8 “An act of individual saving means – so to speak – a decision not to have dinner to-day. But it does not necessitate a decision to have dinner or to buy a pair of boots a week hence or a year hence or to consume any specified thing at any specified date. Thus it depresses the business of preparing to-day's dinner without stimulating the business of making ready for some future act of consumption. It is not a substitution of future consumption-demand for present consumption-demand, – it is a net diminution of such demand.” (Keynes [1936] CW 7: 210)
9 “[…] professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is a case of choosing those which, to the best of one's judgement, are really the prettiest, nor even those which average opinion expects genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.” (Keynes [1936] CW 7: 156)
10 Put differently, “a monetary economy is not an ‘as if barter’ economy precisely because, when money can be held as a store of value, the rate of interest also acquires a crucial role in portfolio allocation decisions, which may undermine its capacity simultaneously to coordinate the allocation of resources over time” (Laidler Citation2010: 54).
11 As argued by Bibow (Citation2000), Keynes's assumption of exogenous money features a kind of exogeneity due to bank behaviour: “the exogeneity position represented in The General Theory runs counter to both verticalism and horizontalism” (Bibow, Citation2000: 533). As already stated in the Treatise on Money, banks have their own liquidity-preference schedule, so that they can easily run counter to both bullish or bearish private actors, and against central bank policy. An exogenous money supply means cooperative behaviour on the part of banks, which allows us at the analytical level to leave aside monetary disturbances, and focus attention on the issue of the coordination of long-term expectations.
12 In Keynes’ own words: “[…] if competition between unemployed workers always led to a very great reduction of the money-wage, there would be a violent instability in the price-level” (Keynes [1936] CW 7: 253)
13 See, for example, “I think the argument for public works in this country is much weaker than it is in Great Britain. […] Here you can function as though you were in a closed system, and […] for such a system I would use as my first method operating on the long rate of interest. I think in this country deliberate public works should be regarded much more as a tonic to change of business conditions, but the means of getting back to a state of equilibrium should be concentrated on the rate of interest. That condition not being so in Great Britain, one had to lay great stress on public programs but in this country I should operate on the rate of interest.” (Keynes, summer 1931, Harris Foundation meeting, quoted in Moggridge and Howson Citation1974: 458–9)
14 As Keynes wrote to Robbins in 1943, “much less effort is required to prevent the ball rolling than would be required to stop it rolling once it has started. […] After the slump has fully developed, the relevant figures get dreadfully large” (Keynes [1943] CW 27: 316).
15 See Friedman's Theory of The Consumption Function (Citation1957).
16 We should here make clear the meaning of adaptive expectations, for the wording used by Friedman can easily be misleading. The existing literature defines ‘adaptive’ expectations as a mechanical first order learning process. In his early works Friedman used this econometric device to frame expectations, especially in his Theory of the Consumption Function (1957). But he soon moved far beyond this simplistic formalisation of expectation, whilst not going as far the extreme treatment of rational expectations in the style of Lucas. ‘Adaptive’ is the proper term to characterise Friedman's individuals, since for him people really needed time to change their mind and to adapt to a changing environment. But Friedman's sophisticated treatment of personal expectations is alien to any kind of mechanistic formalisation of myopic individuals.
17 In Dwyer's words: “Friedman's economic theory and his use of statistics reflected a common background theory: Personal probability, which is Bayesian and the basis of Savage's explicitly Bayesian theory of statistics. The commonality is not an accident: People use personal probability to assess various possible states of the world, whether assessing the prospect of finding a job or the informativeness of a hypothesis. Personal probability is the basis of Friedman's expected utility theory and of his friendly criticisms of rational expectations. Personal probability is also the basis of Friedman's empirical work”. (Dwyer Citation2016: 582)
18 Noticeably, all the metaphors given in Friedman's paper dedicated to speculation (“In Defense of Destabilizing Speculation” Citation1960) can be assigned to risk rather than uncertainty: heads or tails, the Monte Carlo roulette wheel, or lottery tickets. In all the cases mentioned by Friedman the full distribution as well as the likelihood of occurrence is fully known. It is not possible for the markets under consideration not to provide the right signals to private actors.
19 Regarding expectations, Friedman argued: “The only probability notion I can make sense of is personal probability in the spirit of Savage and others. Keynes's degree of belief is in the same family. In fact I believe that Keynes's contribution in his Probability book has been underrated and overlooked.” (Friedman's interview in Snowdon and Vane Citation1999: 132) Unfortunately, Friedman did not identify the gap that remained between his own treatment of uncertainty and Keynes’.
20 Hoover (Citation1984) rightly framed his dividing line between Monetarism mark I and Monetarism mark II along this distinction between the New Classical rational expectations approach and Friedman's adaptive expectations.
21 See for example: “There is a tendency to take it for granted that a high level of recorded unemployment is evidence of inefficient use of resources, and conversely. This view is seriously in error. A low level of unemployment may be a sign of a forced-draft economy that is using its resources inefficiently and is inducing workers to sacrifice leisure for goods that they value less highly than the leisure under the mistaken belief that their real wages will be higher than they prove to be. Or a low natural rate of unemployment may reflect institutional arrangements that inhibit change. A highly static rigid economy may have a fixed place for everyone whereas a dynamic, highly progressive economy, which offers everchanging opportunities and fosters flexibility, may have a high natural rate of unemployment” (Friedman Citation1977: 355).
22 Noticeably, this idea of a cyclical reaction pattern applies to the changes in the rate of inflation in the 1969 paper, whereas it later applies to the rate of change in nominal income when Friedman renounces disentangling changes in real income from changes in the price level.
23 Because of its crowding-out effect “fiscal policy has, in [his] view, been oversold in a very different and more basic sense than monetary policy” (Friedman and Heller Citation1969: 50). Indeed: “the state of the government budget determines what fraction of the nation's income is spent by individuals privately” (Friedman, in Friedman and Heller Citation1969: 50). Besides, it “has a considerable effect on interest rates” (Friedman, in Friedman and Heller Citation1969: 50).
24 A similar statement, quite more explicit, was made in 1948, when Friedman already considered that a policy device that is expected to be able to moderate business fluctuations “would lead to patterns of expectations on the part of businessmen and consumers that would make it rational for them to take action that would damp fluctuations still more” (Friedman Citation1948: 257). On this issue, see Dellas and Tavlas (Citation2016).
25 “In the system I have just described, the total quantity of any monetary aggregate would be determined by the market interactions of many institutional and millions of holders of monetary assets. It would be limited by the constant quantity of high-powered money available at ultimate reserves. The ratios of various aggregate to high-powered money would doubtless change from time to time, but in the absence of rigid government controls […] the ratios would change gradually and only as financial innovations or changes in business and industry altered the proportions in which the public chose to hold various monetary assets.” (Friedman, Citation[1984] 1987: 423–4)
26 See for example the following quotation: “It must be the avowed and deliberate business of the Government to make itself responsible for the wholesale collection and dissemination of industrial knowledge. The first condition of successful control and usual interference of whatever kind from above is that it must be done with knowledge.” (Keynes [1927] CW 19: 643).
27 On this, see Keynes’ several buffer stock schemes in volume 21 of his collected writings.
28 See for example the following quotation: “Unfortunately the more pessimistic the Chancellor's policy, the more likely it is that pessimistic anticipations will be realised and vice versa. Whatever the Chancellor dreams, will come true! We must begin by resuscitating the national income and the national output” (Keynes [1933] CW 21: 184).