Keynesian economics has witnessed a remarkable resurgence since the crisis of 2008. The inability of mainstream economics to predict or explain the crisis led many economists to become skeptical of its core macroeconomic tenets. Several have turned the clock back to the ideas of Keynes to make sense of the housing bubble and the ensuing recession.
One such explanation inspired by the General Theory emphasizes the endemic uncertainty of the future and its implications for market stability. Championed by Paul Davidson1 and popularized by Robert Skidelsky,2 this line of thought blames the crisis and recession on the fickle expectations and “animal spirits” that guide investment in a market economy.3
Per this thesis, in an uncertain world, entrepreneurs and investors suffer from mood swings. Optimism regarding the future abruptly gives way to pessimism. Fluctuations in economic activity are the result of these variations in outlook.
With its focus on uncertainty, this line of thought bears a striking resemblance to Austrian ideas. Moreover, its rejection of mathematical probability as a foundation for expectations is echoed by several prominent Austrian economists.
Nevertheless, while Keynesians conclude that the uncertainty of the future renders a market economy inherently unstable, Austrians embrace uncertainty without losing faith in the order generated by a market economy. What lies at the root of this puzzle?
Keynes on Expectations, Uncertainty, and Market Stability
Think of Mary, a plastic bottle manufacturer drawing up plans to open a new factory. Given the durability of the investment, her decision is based on a set of long-term expectations. How does Mary arrive at these estimations of future prices?
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