Dow’s Uncertainty

Sheila Dow Uncertainty: A Diagrammatic Treatment. Economics: The Open-Access, Open-Assessment E-journal, 10 (2016-3): 1-25.

According to the abstract:

The purpose of this paper is to clarify the difference between the mainstream and Keynesian understandings of uncertainty … .

Also,

The paper offers a simple diagrammatic representation of these differences, and illustrates its use with different depictions of the [financial] crisis [of around 2008], its aftermath and the policy response appropriate to each understanding.

The argument of the paper seems aimed at policymakers and their advisers and potential advisers who still hold the old mainstream views. It is unfortunate that Prof. Dow, who is in a good position to know, thinks that such people still exist after the crises of around 2008. For me, this aspect of the paper seems to be from some remote age – even more remote than that of Keynes’ Treatise, and so hard to follow. But I am clearly not the intended audience. I do agree, though, that:

It is urgent that policy address the potential for uncertainty to aggravate continuing instability. But it is important for policy-makers to understand how differently such a statement is understood from different perspectives. Until the different ways of analysing uncertainty are acknowledged and understood, the policy discourse will continue to be mired in confusion.

Something like Dow’s diagrams seem to me essential. I imagine a far future in which policy makers have suffered another great moderation and no longer value whatever previous generations have learnt about uncertainty. But then some surprising events happen which cause them concern. From the back of a cupboard someone produces Dow’s diagrams. This attracts their interest and they read Dow’s conclusions. This will be very helpful if they really are building up to a crisis, but they will surely want more.

It seems to me that the problem with the old mainstream view was that it mixed together some sound reasoning with a little dross, which was overlooked but which eventually proved significant. Dow’s paper is a great improvement, but it would be foolish to suppose that it was pure, so we should always strive to refine it. Here is my attempt, biased on my own work and reading of Keynes.

From the perspective of Keynes and his fellow mathematicians, conventional stability is only ever a contingent, short-term phenomenon, because of the nature of financial markets. Given radical uncertainty, there are no true prices to act as benchmarks, to which markets can return after a crisis. Yet conventional judgements build up, as when group-think mistakes temporarily successful (perhaps lucky) speculation for wise investment. This fuels instability. The first focus of policy from this perspective therefore has to be vigilance and insight in monitoring financial markets for signs of increasing fragility, such as growing confidence in speculations and common assumptions. The focus of policy addressed to moderating any tendency for increasing uncertainty would involve promoting stability through appropriate design of practices, conventions and institutions.

We should also be looking to add our own key-points. My suggestions:

  • A growing confidence in conventional beliefs and dismissal or ridiculing of alternatives, when those beliefs are actually ill-founded group-think, should be taken as a warning sign and remedied. In particular, Keynes’ distinction between pseudo-mathematics and sound mathematics is vital to economics, and the failures of the pseudo such not discourage the use of the sound, which may be vital. Sound institutions, educational, media and polictical, are needed to support this.
  • That a desire for too narrow a form of ‘stability’ is harmful. What one wants is a healthy, manageable, instability, resembling stability in the short-term (to support learning and investment) with innovation in the long-term (to enable sustainability, effectiveness and necessary change).
  • There is an urgent need to identify incentive structures that are compatible with such long-run sustainability.

Dave Marsay

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