The idea of the future being different from the present is so repugnant to our conventional modes of thought and behaviour that we, most of us, offer a great resistance to acting on it in practice.
The idea of the future being different from the present is so repugnant to our conventional modes of thought and behaviour that we, most of us, offer a great resistance to acting on it in practice.
John Maynard Keynes (1883-1946), the British economist who developed the theory that increasing government deficits stimulate a sluggish economy, was long the guiding light of liberal economists. He is considered one of the major economists of the 20th century. And these days, he is enjoying a comeback.
In his times, he quarreled with laissez-faire economic policies, and with the beliefs that all uncertainty could be reduced to measurable risk, that asset prices always reflected fundamentals and that unregulated markets would in general be very stable.
Keynes created an economics whose starting point was that not all future events could be reduced to measurable risk. There was a residue of genuine uncertainty, and this made disaster an ever-present possibility, not a once-in-a-lifetime “shock.” Investment was more an act of faith than a scientific calculation of probabilities. And in this fact lay the possibility of huge systemic mistakes.
His basic question was: How do rational people behave under conditions of uncertainty? The answer he gave was profound and extends far beyond economics. People fall back on “conventions,” which give them the assurance that they are doing the right thing. The chief of these are the assumptions that the future will be like the past (witness all the financial models that assumed housing prices wouldn’t fall) and that current prices correctly sum up “future prospects.” Above all, we run with the crowd. A master of aphorism, Keynes wrote that a “sound banker” is one who, “when he is ruined, is ruined in a conventional and orthodox way.”
But any view of the future based on what Keynes called “so flimsy a foundation” is liable to “sudden and violent changes” when the news changes. Investors do not process new information efficiently because they don’t know which information is relevant. Conventional behavior easily turns into herd behavior. Financial markets are punctuated by alternating currents of euphoria and panic.
Keynes’s prescriptions were guided by his conception of money, which plays a disturbing role in his economics. Most economists have seen money simply as a means of payment, an improvement on barter. Keynes emphasized its role as a “store of value.” Why, he asked, should anyone outside a lunatic asylum wish to “hold” money? The answer he gave was that “holding” money was a way of postponing transactions. The “desire to hold money as a store of wealth is a barometer of the degree of our distrust of our own calculations and conventions concerning the future. . . . The possession of actual money lulls our disquietude; and the premium we require to make us part with money is a measure of the degree of our disquietude.” The same reliance on “conventional” thinking that leads investors to spend profligately at certain times leads them to be highly cautious at others. Even a relatively weak dollar may, at moments of high uncertainty, seem more “secure” than any other asset.
It is this flight into cash that makes interest-rate policy an uncertain agent of recovery. If managers of banks and companies hold pessimistic views about the future, they will raise the price they charge for “giving up liquidity,” even though the central bank might be flooding the economy with cash. That is why Keynes did not think cutting the central bank’s interest rate would necessarily — and certainly not quickly — lower the interest rates charged on different types of loans. This was his main argument for the use of government stimulus to fight a depression. There was only one sure way to get an increase in spending in the face of an extreme private-sector reluctance to spend, and that was for the government to spend the money itself.
Re-reading the texts at issue, I’ve just noticed something which puts in question some of what I’ve written above. Keynes is ambiguous about the chief convention. In the GT he writes: “The essence of the convention – though it does not, of course, work out quite so simply – lies in assuming that the existing state of affairs will continue indefinitely, except in so far as we have specific reasons to expect a change.” This implies that in the short-term where there can be “specific reasons to expect a change”, conventional practice will take account of them. This implication is also present in the 37 QJE article where what we are said to “largely ignore” is “the prospect of future changes about the actual character of which we know nothing”. This allows for the taking account of “the prospect of future changes the actual character of which we know” something. The TOM passage and the _Eugenics Review_ article, on the other hand, make claims about the mentality at issue which point to a strongly anchored psychological influence in “most of us” which leads us to assume the future will be like the present even “in those cases where we do have good reason to expect a definite change.” “The idea of the future being different from the present is so repugnant to our conventional modes of thought and behaviour that we, most of us, offer a great resistance to acting on it in practice.”
(1937)