Davidson’s Post Keynesian Perspective …

Paul Davidson Is Probability Theory Relevant for Uncertainty? A Post Keynesian Perspective Journal of Economic Perspectives- Volume 5, Number I -Winter 1991-Pages 129-1 43.

Davidson agrees with Keynes’ criticism of classical economics that bit to readily accepts many axioms, and in particular questions the applicability of conventional probability theory (that uncertainty can be represented by a number). He notes:

Solow [like Keynes] has argued that there is an interaction of historical-societal circumstances and economic events which entail continual structural breaks.

 Following Hicks he notes that:

… an environment of true uncertainty (that is, one which is nonergodic) occurs whenever an individual cannot specify and/or order a complete set of prospects regarding the future, because the decision maker either cannot conceive of a complete list of consequences that will occur in the future; or cannot assign probabilities to all consequences because “the evidence is insufficient to establish a probability” so that possible consequences “are not even orderable”.

 Moreover

Knight associated uncertainty with “high degree unique” situations and noted that our presupposition regarding probabilistic (but risky) knowledge about the future is based on a belief in the uniformity and timeless consistency of nature.

Davidson concludes:

Probabilistic analysis of waiting and option value recognize only a brief need to postpone spending over time. However, only the Post Keynesian uncertainty concept provides a basis for a long-run demand for liquidity.

Keynes’s revolutionary analysis, where money is never neutral and liquidity matters, is a general theory of an economy which permits the unpredictability of the future in certain crucial areas of economic decision making to have important economic consequences.

He goes on:

… the expected utility theorists presumption that future prospects can be completely ordered, tends to lead to the argument that individuals in free markets do not make persistent errors and they know better than the government how to judge the future. Basing general policy rules on these assumptions can result in disastrous advice for governmental officials facing situations where private sector economic decision makers believe that the future cannot be reliably predicted from past experience.

If economists can recognize and identify when these (nonergodic) economic conditions of true uncertainty are likely to be prevalent, government can play a role in improving the economic performance of markets. … Government needs to set the “rules of the game” in such a way as to eliminate the anti-social results of decision making under uncertainty, although it need not get involved in the nitty-gritty decisions regarding the allocations of real resources, like planning at the factory level.

Comments

Davidson calls himself a post Keynesian because formerly those who called themselves Keynesians had paid too little attention to the significance of Keynes’ non-probabilistic (‘Knightian’) uncertainty, as emphasised in Keynes update to his theory.

Davidson promotes a role for government in recognizing when there is unusually critical uncertainty. He does not seem to consider that a suitably enlightened academia and media might help develop a more informed market, that might then respond more appropriately to any warnings. Nor does he consider whether a free-for-all, complete with surprises and set-backs, might not be better than creating a regulatory focus that could become corrupted. But he does make a good case that uncertainty matters.

See Also

My notes on economics, uncertainty.

David Marsay

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