Re: Paul D. on this year's Nobel

[Ted Winslow <egwinslow@xxxxxxxxxx>]

Gary Mongiovi wrote:

> I take it to mean that the
> economist's conception of rationality is not very useful, because  (i)
> I don't
> think people are generally irrational; and (ii) I don't see how general
> propositions about social behavior can be derived if human beings are
> presumed
> to be irrational.

The "multiplier" is a "general proposition" (in the limited sense
required by the ontological hypothesis of "organic unity") about social
behaviour.  Its basis is "the psychological propensity to consume."

According to Keynes, this propensity is to an important degree
"irrational" (in the sense of this word I earlier attributed to Keynes)
because it is rooted in "the instincts of Puritanism," in "the hoarding
instinct," a form of the "purposiveness" that is "a somewhat disgusting
morbidity, one of those semi-criminal, semi-pathological propensities
which one hands over with a shudder to the specialists in mental
disease."

Keynes's claim about variation in "liquidity preference" is another such
general proposition.  He claims the variation is rooted in an irrational
"instinctive or conventional feeling" about money that "operates, so to
speak, at a deeper level of our motivation" and "takes charge at the
moments when the higher, more precarious conventions have weakened."

This general proposition, like the "multiplier," provides a basis for
rational prediction, in particular for the form of rational prediction
which Keynes calls rational "speculation," i.e. rational forecasting of
"the psychology of the market."

Keynes understood the condition in the U.S.  bond market in 1932 to be
"a financial crisis or crisis of liquidation" of the kind generated by
such an irrational increase in liquidity-preference in the face of a
collapse in the conventional foundations of expectations.  This created
a psychological atmosphere in which "scarcely anyone could be induced to
part with holdings of money on any reasonable terms." (VII, 207-8)

He claimed this created a possibility for practically certain
speculative profit.  For example, in a July 7, 1932 letter to C.L.
Baillieu, he says that:

"the most striking feature of the immediate situation is the
extraordinary disparity between yields in London and yields in New York
of comparable securities.  It seems to me quite impossible that the
present situation can long persist.  And I should have supposed it to be
probable that the readjustment would be brought about by a substantial
rise in the prices of prime fixed-interest securities in New York.  The
present may be the chance of a lifetime for the purchase of the latter.
Obviously everyone in New York is scared so stiff as to be unable to
move.  But that may be the opportunity of others away from any
unsettling influence of the local atmosphere.  No serious risk can arise
unless the existing financial system in America is going to peg out
altogether.  I suppose that that is just possible, but I cannot believe
that it is probable." (XII, 113)

The "conventional" forecasting practices to which Keynes claims the "mob
psychology" underpinning the forecasts of "the vast majority of those
who are concerned with the buying and selling of securities" (who "know
almost nothing whatever about what they are doing") leads are also
general propositions about social behaviour.

These practices are also irrational because of their roots in
"instincts."   Their psychological function is denial of the fact of
"uncertainty,"  a fact which, if consciously acknowledged (as it is by
Paul's "sensible" agent), would produce disabling anxiety.

"The need for action and for decision compels us as practical men to
overlook this awkward fact [that 'we simply do not know']" because
"peace and comfort of mind require that we should hide from ourselves
how little we foresee.  Yet we must be guided by some hypothesis.  We
tend, therefore, to substitute for the knowledge which is unattainable
certain conventions, the chief of which is to assume, contrary to all
likelihood, that the future will resemble the past.  This is how we act
in practice." (XIV, 114 and 124)

On Keynes's premises, the practices generate beliefs about the future
knowable practically with certainty to be false. The "chief" convention,
for instance, contradicts the fact that "the future never resembles the
past - as we well know." (XIV, p. 124)  Not only will the future be
different from the past, "it will be different from anything we could
predict."  "We do not know what the [long run] future will bring, except
that it will be quite different from anything we could predict."
(Keynes, quoted  in Skidelsky, vol. 3, p. 33)

These general propositions about conventional forecasting also provide
the basis for the kind of rational prediction Keynes calls rational
"speculation."

"Very few American investors buy any stock for the sake of something
which is going to happen more than six months hence, even though its
probability is exceedingly high; and it is out of taking advantage of
this psychological peculiarity of theirs that most money is made." (XII,
p. 78 )

Paul takes a different view both of Keynes's argument and of reality.

"The decision-maker believes that during the lapse of calendar time
between the moment of choice and the date(s) of pay-off, unforeseeable
changes will occur.  In other words, the decision-maker believes that no
information regarding future prospects exists today and therefore the
future is not calculable, even if she is competent to perform the
mathematical calculations necessary to calculate probabilities of
conditional events, providing she had the necessary information.  This
is uncertainty (or ignorance about future consequences) in the sense of
Keynes and the Post Keynesians, and the longer the lapse between the
choice and consequence, all other things being equal, the more likely
the individual is to suspect she is making a decision in an uncertain
environment."  (Davidson, Controversies in Post Keynesian Economics, p.
47)

"If the future is transmutable and therefore uncertain even in the long
run,then, as in Keynes' analysis, money is never neutral (Keynes, 1973a,
pp. 408-411). When agents recognize that they live in transmutable
economic environment, then a positive long-run demand for liquidity
(that permits agents to indefinitely defer using their earned claims on
resources) is a sensible long-run response that endows fiat money with a
long-run positive real value as a hedge against an endemically
unpredictable future." (Davidson, "Reality and Economic Theory")

For the reasons I've given, these claims misinterpret Keynes.  They
also, in my judgment, involve empirically false and self-contradictory
premises.  Most people are not "sensible" in Paul's sense and a
"sensible" "positive long-run demand for liquidity" requires, as Paul
himself points out elsewhere, a rational basis for believing that, in
the long run, inflation will not prevent money from being "a good store
of value to meet future liabilities for the purchase of goods and
services."  The assumption that such a basis exists contradicts the
assumption that the long run future is unpredictable.

Ted