Journal of Post Keynesian Economics

ISSN: 0160-3477 (Print) 1557-7821 (Online) Journal homepage: http://www.tandfonline.com/loi/mpke20

Alternative Keynesian and Post Keynesian

Perspective on Uncertainty and Expectations
J. Barkley Rosser Jr.
To cite this article: J. Barkley Rosser Jr. (2001) Alternative Keynesian and Post Keynesian
Perspective on Uncertainty and Expectations, Journal of Post Keynesian Economics, 23:4,
545-566, DOI: 10.1080/01603477.2001.11490299
To link to this article: http://dx.doi.org/10.1080/01603477.2001.11490299

Published online: 03 Nov 2015.

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Date: 21 November 2016, At: 03:46

J. BARKLEY ROSSER JR.

Alternative Keynesian and

Post Keynesian perspectives on
uncertainty and expectations
It is a curious fact that A Guide to Post-Keynesian Economics (Eichner,
1979) has no chapter on "Uncertainty and Expectation," despite the fact
that this topic was central to the concerns of John Maynard Keynes. Two
phenomena may be responsible for this lacuna.
First, the concept of uncertainty as developed by Keynes was largely
hijacked by James Tobin (1959) and turned into a concept of quantifiable risk. Although risk and uncertainty are not identical concepts, Tobin
made it seem acceptable to treat them as if they were. One finds many
books that will use the term "uncertainty," which is nonquantifiable in
the view of Keynes and now the Post Keynesians as well, and discuss it
in terms of objectively measurable and quantifiable risk. This approach
was picked up by the emerging financial economists who would incorporate it into a model assuming rational expectations and efficient markets, despite Tobin's own skepticism regarding these matters (Weisman,
1984). This violated the accepted division between measurable risk and
unmeasurable uncertainty that had been introduced by Frank Knight
(1921) in the same year that Keynes's own Treatise on Probability was
published.
Second, there was the baleful influence of the rational expectations
"revolution," which, up to 1979, Post Keynesians had not felt the need to
respond to seriously as it seemed such a patently ridiculous idea to them.
Indeed, when most of the 1979 Guide was written in the mid-1970s, the
idea was not yet viewed as important by most economists in general.
Although some Post Keynesian economists worried about uncertainty

The author is Professor of Economics and the Kirby L. Kramer Jr. Professor of
Business Administration at the James Madison University, Harrisonburg, Virginia.
He acknowledges useful remarks from Paul Davidson and Richard P.E Holt. An
abridged version of this paper is forthcoming as a chapter entitled "Uncertainty and
Expectations:' in Richard P.F. Holt and Steven Pressman (eds.), The New Guide to
Post Keynesian Economics (London: Routledge, 2001).
Journal of Post Keynesian Economics /Summer 2001, Vol. 23, No.4 545
2001 M.E. Sharpe, Inc.
0160-3477 12001 $9.50 + 0.00.

546 JOURNAL OF POST KEYNESIAN ECONOMICS

and expectation in the original Keynesian sense prior to 1979 (Shackle,

1955,1972; Kregel, 1976; Loasby, 1976; Davidson, 1978; Vickers, 1978;
Hicks, 1979), there was no concerted effort to critique the rational expectations assumption on the grounds of Keynesian uncertainty. The
concept of rational expectations had been introduced into microeconomics by John Muth (1961), but then was applied to macroeconomics by Robert Lucas (1972). Lucas used this approach to argue against
the idea that governments can systematically affect the behavior of people
in the economy-because people will take into account the actions of
the government and act in ways to nullify anything the government tries
to do, based on their ability to forecast accurately on average what the
economy will do in the future.
During the late 1970s and early 1980s this "New Classical" view, with
its pro-laissez-faire implications, began to sweep much of the economics profession and established itself as the dominant approach in macroeconomics, especially in the United States. Since then systematic critiques
of rational expectations by Post Keynesians have been voluminous, and
the effort has generated much discussion of the basic concepts of uncertainty and expectation themselves. It has become clear that in order to
combat the policy argument, "nothing can (or should) be done," that
seemed to come out of the rational expectationslNew Classical view, the
core assumptions regarding how people form expectations would need
to be understood. This then opened the door for the reconsideration of
the old Keynes view of uncertainty as fundamental and unquantifiable.
In this way, the Keynes view of uncertainty undermines the foundation
of the rational expectations assumption and the policy arguments that
flow from it.

Keynes on uncertainty and expectation

The reason that people form expectations is important since they actually act on the basis of what they think is going to happen in the future.
Rational expectations provides an answer to this problem that is very
neat and has enormous appeal to many theorists because of its simultaneous simplicity, while granting great insight to economic agents: on
average, people expect what will really happen. This makes them insightful, but also makes it easy for the theorist who can simply impose a
theory of reality and say that people understand it and expect what it
forecasts. The assumption is that they expect what the theorist says will
happen, then reinforces the forecast that it really will happen. People do
what the theorist says they will, because they know that the theorist is

PERSPECTIVES ON UNCERTAINTY AND EXPECTATIONS 547

right, and in so doing make the theorist right. Following Lucas and the
other New Classicals, that rationally expected outcome will be a full
employment nirvana, unless the government messes things up by confusing people's expectations through its arbitrary policy actions. Lucas
openly argued that his view overthrew the arguments of Keynes, which
he deemed to be outdated and irrelevant.
Thus, it is understandable that Post Keynesians might respond to
such an argument by going back to Keynes himself in search of a critique of such a simpleminded view of expectations formation. Post
Keynesians thus rediscovered the old Keynes idea that the flighty bird
of real capital investment is not driven by long-run rational expectations, which are impossible, but rather by essentially subjective and
ultimately irrational "animal spirits," a spontaneous urge to action in
the face of uncertainty.
Keynes presented his most extensive thoughts about uncertainty in his
1921 Treatise on Probability (1973, Vol. VIII). He had some later remarks on the topic in the 1936 The General Theory of Employment,
Interest and Money (1973, Vol. VII) and in his 1937 article, "The General Theory of Employment" (1973, Vol. XIV). The most important link
with expectation formation comes in the famous Chapter 12 of The General Theory, "The State of Long-Term Expectation" (1973, Vol. VII).
Here the ubiquity of unquantified uncertainty is seen as causing people
to look to the current facts and to the average state of opinion, the "state
of confidence," to form their expectations. They will base their expectations on what they put "weight" on, a point we shall return to later.
But while the state of long-term expectations may remain steady for
long periods, it is also subject to sudden and violent shifts, sometimes
caused by speculation in markets (sometimes irrational) as well as by
shifts of psychology. In Chapter 12 Keynes puts forth his theory of "animal spirits." He argues that these spirits lie behind capital investment,
"a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities" (1973, Vol. VII, p. 161). Chapter 13 of The General
Theory also argues that uncertainty about the future of interest rates
underlies liquidity preference and, thus, constitutes part of the demand
for money as well.
There has been much controversy about Keynes's views on uncertainty. One reason for this is that Keynes presented several different
arguments regarding uncertainty, including, over time, a possible shift
in his view toward more emphasis on its absolutely unquantifiable nature. However, the place to start is the 1921 Treatise on Probability,

548

JOURNAL OF POST KEYNESIAN ECONOMICS

which undoubtedly served as the foundation of his later views, and is

where he presents the fullest discussion of the matter. In that volume he
declares:
There appear to be four alternatives. Either in some cases there is no
probability at all; or probabilities do not all belong to a single set of magnitudes measurable in terms of a common unit; or these measures always
exist, but in many cases are, and must remain, unknown; or probabilities
do belong to such a set and their measures are capable of being determined by us, although we are not always able so to determine them in
practice." (1973, Vol. VIII, p. 33)

It is widely argued that he had the first case in mind for economic
matters when he contemplated long-term outcomes of decisions. Thus
in his 1937 article he declares regarding "uncertain knowledge":
not only mean merely to distinguish what is known for certain from what
is only probable. The game of roulette is not subject, in this sense to
uncertainty; nor is the prospect of a Victory bond being drawn. Or, again,
the expectation of life is only slightly uncertain. Even the weather is only
moderately uncertain. The sense in which I am using the term is that in
which the prospect of a European war is uncertain, or the price of copper
and the rate of interest twenty years hence, or the obsolescence of a new
invention, or the position of private wealth owners in the social system in
1970. About these matters there is no scientific basis on which to form
any calculable probability whatever. We simply do not know. (1973, Vol.

XIV, p. 113)

The second case is associated with the problem of noncomparability

or incomplete ordering, that he discusses at the end of Chapter 3 ("The
Measurement of Probabilities") of the Treatise on Probability. He argues that some series of possible events may be ordinally ranked with
respect to each other in terms of greater or lesser probability, but without any cardinality to these probabilities. But then there may be another
series of events that can also be so ranked among themselves, but that no
possible event from this series can be compared with any possible event
from the first series. Or, there may be some event that is in both series
and can be compared with every event in each series, but that no others
can be. I A possible argument for such noncomparabilities of series or

1 For discussions of implications of this noncomparability idea, especially to the

debate over econometrics between Keynes and Tinbergen, see Rowley and Hamouda
(1987) and O'Donnell (1990).

PERSPECTIVES ON UNCERTAINTY AND EXPECTATIONS 549

noncardinalities within series might be (using classical frequentist statistics that Keynes rejected) that each possible event has a differentshaped probability distribution. Thus, one event might have a Gaussian
normal distribution with a lower mean than the other. But the other might
be skewed and have a lower median and mode than the former.
The third case is not explicated by Keynes, but might reflect the position of Knight (1921) according to Lawson (1988), who categorizes views
on probability according to whether they are quantifiable or nonquantifiable and whether they are subjective or objective. Thus Keynes
is nonquantifiable-subjective; Knight is nonquantifiable-Qbjective; Savage (1954) is quantifiable-subjective, and rational expectationists such
as Muth (1961) are quantifiable-Qbjective.
The fourth case represents epistemological problems of how to know
what we know, whose causes may be many and have been debated at
length by Post Keynesian economists. A few simple examples would be
where cases from which one might calculate the probabilities are very
hard to observe or generate data that is hard to measure or estimate, or
that there are too few cases to meaningfully estimate such probabilities.
Furthermore, it must be made clear that Keynes recognized the possibility of quantifying fairly exact probabilities for certain kinds of cases,
as in the roulette wheel example given above. He also talks about the
classic examples of flipping coins and rolling a die. He accepts that for
some situations insurance companies may be able to make such quantifiable calculations, but that there are others for which their estimates are
essentially arbitrary guesses.
An important aspect of Keynes's view of probability is that he viewed
it as fundamentally subjective-something that can be constructed from
internal logic rather than from mathematical calculations of distributions from external observations. Possible events are to be viewed in
comparison with each other by their "probability relation," possibly
unmeasurable. He raises the problem of induction, even for the cases
where a priori knowledge and logic might well yield an apparently definitive quantitative answer. Thus, we can say a priori that a fair die will
have a one-sixth probability of landing on each side. But how do we
know it is a fair die, especially if, as we roll it, we see one side coming
up more regularly than the others?
Keynes's subjectivism is more radical and more uncompromising than
that of most other subjectivist probabilists and followers of Bayes, although Poirier (1988) argues that some Bayesians are fully subjective in
the Keynesian sense. Such subjectivists, as von Neumann and Morgenstern (1944) and Savage (1954), see a frequentist underpinning to the

550 JOURNAL OF POST KEYNESIAN ECONOMICS

subjective probabilities assigned by agents. In the usual Bayesian formulation there is ultimately a convergence of the subjective and the objective probability as the number of observations increases, 2 a kind of
foreshadowing of the rational expectations view and one that certainly
assumes an ultimate validity to the concept of "objective probability."
Keynes rejects this ultimate objectivity of probability, despite accepting
that logical deductions can result in reasonable quantified probabilities
some of the time. This subjectivism carries over into Keynes's views on
expectations formation and economic decision-making. There is simply
no way that Keynes would have accepted Muth's (1961, p. 316) view
that expectations are rational in the sense that "expectations of firms (or
more generally the 'subjective' probability of outcomes) tend to be distributed, for the same information set, about the prediction of the theory
(or the 'objective' probability distribution of outcomes)."
As noted above, Keynes suggested that agents form their expectations
based on how much "weight" they put on different possibilities. He discusses this concept of weight in Chapter 6 of the Treatise on Probability-an issue whose philosophical aspects have been discussed by Runde
(1990) and O'Donnell (1990). It is identified with the amount of "relevant evidence" that an agent has gathered regarding the probability of a
possible outcome. It is not the same as the probability of that outcome.
In that regard it is tempting to identify this concept with that of statistical significance in classical frequentist statistics. But it is also clear that
Keynes rejects the definite quantitative comparing of such "weights."
However, he does emphasize that the determination of "degrees of belief' is a rational and logical process. But later, writing of Frank Ramsey
in the Essays in Biography in 1931 (1973, Vol. X, pp. 336-339), he
moved from a view that probability is an objective relation between
propositions (subjectively known through logic) to a view that probability is mostly about "degrees of belief." And those beliefs, which can
change suddenly, are most strongly influenced by current reality, whose
"salience" (Akerlof, 1991) impresses and thus contributes greatly to
"weight," at least for a time.

2 An exception to this is in the infinite dimensional case. When rolling a die with an
infinite number of sides there may be no convergence of Bayesian priors on "objective
posteriors" (Diaconis and Freedman, 1986).

PERSPECTIVES ON UNCERTAINTY AND EXPECTATIONS 551

Post Keynesian perspectives on uncertainty and expectation

Potential surprise and history versus equilibrium

The main figure who developed the implications of nonquantifiable uncertainty was G.L.S. Shackle (1955, 1972).3 He, along with Loasby
(1976), took an uncompromising stance regarding the absolutely ontological nature of Keynesian uncertainty and strongly emphasized its role
in investment, and the unpredictability and the peculiar variability of
investment. This uncertainty was seen as tied to the creativity and free
will of the investor, his or her ability to create ex nihilo a new reality that
constantly churns and upsets previous realities as "potential surprises"
emerge. This led him to reject the concept of equilibrium and to declare
that reality is "kaleidic" (Shackle, 1974)-constantly changing and swirling like the colors of a kaleidoscope. Coddington (1982)4 cited Shackle
and Loasby approvingly as exponents of the logical implications of Keynesian uncertainty, even as he rejected the idea as "nihilistic."
Eventually Shackle (1969) argued that potential surprise lay at the
basis of the creative decision-making of firms. This inspired others to
attempt to formalize this concept. Vickers (1978) postulates "surprise
functions" and "attractiveness functions" that represent their "attentioncommanding" power, which draws decision-makers to focus upon different potential surprises as the basis for behavior. This approach has
drawn criticism for potentially opening the door to imputing subjective
probabilities, and thus violating the spirit of true Keynesian uncertainty
(Williams and Findlay, 1986), a criticism rejected by Vickers (1986)
who argues that the irreversibility of time renders this critique irrelevant. This Shackle-Vickers approach to microeconomic decision-making by firms has been further developed by Katzner (1990).
Running through the arguments of Shackle, Loasby, and Vickers is an
emphasis on the unidirectional nature of time and the significance of this
for the unknowability of the future and the ontological nature of uncertainty. This theme has been emphatically emphasized by others as wellmost clearly Bausor (1982-1983, 1984). He draws into the argument
two strands that emphasize the irrevocability of decisions. One is the

3 Shackle is one of the rare Post Keynesians who is also admired by Austrian
economists (O'Driscoli and Rizzo, 1985).
4 Estrin and Holmes (1985) respond to Coddington's critique of Keynes and argue
that Keynes saw indicative planning as an appropriate response to uncertainty based
on his 1926 The End of Laissez-Faire (1973, Vol. IX).

552 JOURNAL OF POST KEYNESIAN ECONOMICS

entropy-related argument of Georgescu-Roegen (1971), which argues

that the tendency for the degree of disorder (entropy) to increase over
time in the universe according the Second Law of Thermodynamics, is
the fundamental reason for the unidirectional nature of time. The other is
the eloquent distinction between historical time and equilibrium drawn
by Joan Robinson (1974), who argues that actual, nonrepeatable, historical time has little relation to the abstract time appearing in most theoretical economic equilibrium models. In Bausor's work, these themes
reinforce the "kaleidic vision" of Shackle. Gowdy (1985-1986) throws
this discussion into a more explicitly ecological-evolutionary framework.

Nonergodicity and uncertainty

Probably the most influential of all Post Keynesian arguments regarding the ontological foundations of Keynesian uncertainty has been the
identification of nonergodicity as endemic in the dynamics of economic
systems, due to Paul Davidson (1982-1983, 1991, 1994, 1996) drawing
on earlier arguments of Shackle (1955) and Hicks (1979).5 An ergodic
process is one for which time and space averages are equal; what happens at points in time for different initial states coincides with what
happens over time for a given initial state. This suggests that over time
economic processes follow averages that can be discovered by rational
agents, thus implying the possibility of rational expectations. Recognizing that Keynes was unaware of this concept, per se, Davidson nevertheless interprets his arguments for uncertainty as implying nonergodicity
of economic time series. For Davidson this becomes a battle-ax with
which to directly attack the rational expectations hypothesis.
One problem that arises-indeed more broadly for the emphasis upon
uncertainty-is how can there be any predictability regarding policy
outcomes if there is such profound uncertainty, essentially the argument
of "nihilism" made by Coddington (1982). Davidson responds to this by
citing Shackle's (1955) argument regarding "cruciality." Potential surprise and nonergodicity arise only with "crucial" decisions, such as major capital investments, or for an individual, the choice of a career. Routine
decisions may well be governed by ergodicity and be somewhat predictable, including much of consumption behavior. But the essential creativity of animal spirits-driven capital investment process is inherently
5 An incomplete list of those citing Davidson's argument includes Rutherford
(1984); Weisman (1984); Gowdy (1985-1986); Rowley and Harnouda (1987);
Lawson (1988); de Carvalho (1988); Carter (1991-1992); McKenna and Zannoni
(1993); Neal (1996); and Rosser (1998, 1999).

PERSPECTIVES ON UNCERTAINTY AND EXPECTATIONS 553

surprising and nonergodic, thereby providing an onotological foundation for uncertainty. Davidson sees uncertainty as the source of the longrun non-neutrality of money, following up on Chapter 13 of Keynes'
General Theory, an argument further developed by Runde (1994).
The issue of stationarity, if not of nonergodicity per se, has attracted
much attention among more conventional time-series macroeconometricians. 6 Thus, many studies have found unit roots in macroeconomic
variables that imply level nonstationarity (Christiano and Eichenbaum,
1990), although unit roots can be consistent with trend stationarity, which
would seem to violate the spirit of Keynesian uncertainty. A unit root
exists when a change in a variable persists and the variable does not
return to its previous value.
There has also been an effort by many to model "surprising events"
using leptokurtosis, or "fat-tailed distributions." It is now a stylized fact
that at least most time-series of asset prices exhibit such leptokurtosis,
with some even arguing that it is asymptotically infinite (Loretan and
Phillips, 1994).7 However, such models generally still assume some kind
of stationarity of the mean, which would lead Davidson at least to argue
that they are not truly Post Keynesian in approach because they contain
an element of ergodicity, although in the case of asymptotically infinite
moments there is a violation of ergodicity, strictly speaking. With regard to the criterion of Davidsonian nonergodicity, such cases must be
viewed as somewhat ambiguous.
Finally, there has recently arisen a new emphasis on "regime switching" (Flood and Garber, 1994). Perhaps more than any of these, this may
come close to the Davidsonian vision, as it implies that there are periods
of "routine" behavior during which ergodicity and predictability may
hold. But then "crucial" decisions are made that move the system to
another position or regime in an unpredictable manner. Despite these
similarities there are major differences between the Flood and Garber
approach and that of Davidson. First, Flood and Garber emphasize

6 The concept of ergodicity is often associated with that of stationarity of a time

series. In fact, an ergodic system will be stationary. However, some stationary systems
may be nonergodic, such as limit cycles or other kinds of cyclical fluctuations that can
arise from well-known Keynesian models, such as that of Hicks (1950), in which a
multiplier-accelerator framework is placed within a context of floors and ceilings to
investment. Thus, non stationarity is a sufficient, but not a necessary condition for
nonergodicity.
7 This extends the argument of Mandelbrot (1963) that unusual events can be
modeled by assuming asymptotically infinite variances. Mirowski (1990) sees this
approach as the fountainhead of fundamental uncertainty.

554

JOURNAL OF POST KEYNESIAN ECONOMICS

government policies rather than private capital investment as the source

of regime switches. Furthermore, they argue that market agents attempt
to forecast such regime switches in futures markets, although not always
successfully. Indeed, they, along with Sargent (1993, pp. 26-27), see
such an approach as consistent with rational expectations in that agents
may be able to fully incorporate the probabilities of such regime switches
into their forecasts as part of the initial data set. Certainly they and other
advocates of this approach do not hold to a view of uncertainty as deeply
ontological and unavoidable, as do most Post Keynesian's, as they argue
that it can be eliminated by governments maintaining wide-known and
time-consistent policies.
Group dynamics

While discussing dynamics in his crucial chapter on "The State of LongTerm Expectation" (Keynes, 1973, Vol. VII), Keynes gives numerous
examples where interactions between agents and their expectations about
each others' expectations play crucial roles. This is implicit in the argument that agents watch closely the "average state of expectations" in
forming their own expectations, if for no other reason than that if they
are wrong they can point to the fact that most others were wrong in
order to avoid blame for their mistakes. The most famous example of
this interaction between agents is his example of the "beauty contest":8
Or to change the metaphor slightly, professional investment may be likened to those newspaper competitions in which the competitors have to
pick out the six prettiest faces from a hundred photographs, the prize
being awarded to the competitor whose choice most nearly corresponds
to the average preferences of the competitors as a whole; so that each
competitor has to pick, not the faces which he himself finds prettiest, but
those which he thinks likeliest to catch the fancy of the other competitors,
all of whom are looking at the problem from the same point of view. It is
not a case of choosing those which, to the best of one's judgment are
really the prettiest, nor even those which average opinion genuinely thinks
the prettiest. We have reached the third degree where we devote our intel-

8 This implies an infinite regress problem in decision-making when one is taking

into account the behavior of other agents that can imply undecidability (Binmore,
1987; Lipman, 1991; Koppl and Rosser, 2001). Conlisk (1996) notes that such infinite
regresses can arise when one is contemplating how to economize on information
searches or calculations. Is it worth economizing on economizing on economizing ... ? (Raiffa, 1968). This is undecidable and can be viewed as an ontological
problem that must be avoided by making a decision "on intuitive grounds" (Johansen,
1977), that is, by relying ultimately on "animal spirits."

PERSPECTIVES ON UNCERTAINTY AND EXPECTATIONS 555

ligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and
higher degrees. (Keynes, 1973, Vol. VII, p. 156)
Observers such as Carabelli (1988), Davis (1993), and Arestis (1996)
see this problem of peoples' uncertainty about each others' expectations
as being the fundamental source of general uncertainty. Since we can
never know for certain at what "degree" other people will be thinking
about how average opinion will be forming its expectation of itself, we
cannot ever know for certain what other peoples' expectations of average opinion will actually be.
This dependence of people for each other on the formation of their
expectations, opens up the possibility of sudden mass changes of these
expectations, "mob psychology." As noted by Rotheim (1988), an early
inkling in Keynes's work on this was an assertion of "organicism," in
his 1926 obituary of Edgeworth, when he declared: 9
The atomic hypothesis which has worked so well splendidly in physics
breaks down in psychics. We are faced at every tum with the problems of
organic unity, of discreteness, of discontinuity-the whole is not equal to
the sum of the parts, comparisons of quantity fail us, small changes produce large effects, the assumptions of a uniform and homogeneous continuum are not satisfied. (Keynes, 1973, Vol. X, p. 262)
Keynes's vision of the interaction of the expectations of different people
leading to sudden and unpredictable changes in group dynamics has
inspired an enormous literature regarding various phenomena. One has
been the topic of speculative bubbles in asset markets (Galbraith, 1954;
Kindleberger, 1999; Shiller, 1989; Rosser, 1997). People bid up the price
of an asset because they expect that other people will also be doing so.
This can become a self-fulfilling prophecy, at least for a while. It is even
possible that such behavior may be "rational" in some sense, although
the sources cited above tend to emphasize the "irrational fad" element
of such behavior. 10 Speculation can also lead to the proliferation of new
assets (Carter, 1991-1992), although the proliferation of new options
may actually induce greater uncertainty rather than reduce it (Bowman
and Faust, 1997).
9 See Rosser (2000) for extended and more general discussion of issues raised in
this statement. Brock (1993) provides an alternative approach to sudden changes in
group dynamics based on the mean-field approach used in statistical mechanics.
10 Glickman (1994) and Davidson (1996) question the usual approach to discussions of speculative bubbles because they reject the concept of a fundamental value
against which a bubble can be defined and measured.

556 JOURNAL OF POST KEYNESIAN ECONOMICS

Another approach along this line has been that of the "sunspot
equlibrium" theories (Azariadis, 1981; Cass and Shell, 1983). In this
approach agents respond to some "extrinsically uncertain" event (sunspots, the Oracle of Delphi's predictions) to believe or not in some outcome that then becomes a self-fulfilling prophecy. Some of this literature
departs from Keynesian uncertainty by positing that the extrinsic event
may obey some known probability distribution, leading Davidson (1996)
to dismiss such models as merely a variety of theories where reality is
unknown in the short run due to some epistemological difficulty, thus
corresponding to Keynes's fourth case of potentially learnable probabilities that are not easily learned. Nevertheless, this approach has the potential for modeling the arbitrariness of social choice if the extrinsic
process is left unknown.
Generally, sunspot models exhibit multiple equilibria, depending on
the state of expectations, which must be determined somehow. Another
large and related literature has focused on the problem of coordinating
expectations in order to select among equilibria (Cooper and John, 1988;
Guesnerie, 1993; Colander, 1996). Davidson (1996) again dismisses these
approaches as merely raising epistemological problems of finding a selfadjusting immutable equilibrium, but the very openness of the system
to the essentially arbitrary choices of the agents suggests that this is not
necessarily the case.
A natural extension of these models is the question of adjustment and
learning processes with regard to the selection of equilibria out of such
a multiplicity of possible self-fulfilling prophecies. It is now clear that
such processes may not be convergent on any equilibria and may generate all kinds of instabilities, and even chaotic dynamics (Brock and
Hommes, 1997; Sorger, 1998; Hommes and Sorger, 1998; Hommes and
Rosser, 2001).11 Their propensity to lead to "self-fulfilling mistakes"
has led Grandmont (1998, p. 742) to declare the existence of an "uncertainty principle: learning, when agents are somewhat uncertain about

II Chaotic dynamics involve sensitive dependence on initial conditions that imply a

small initial error can lead to a wide deviation of outcomes. These have been argued
to undermine the possibility of rational expectation (Grandmont, 1985; Rosser, 1996)
and to represent an independent source of Keynesian uncertainty, along with other
kinds of complex dynamics (Rosser, 1998, 1999). Davidson (1996) argues that
chaotic dynamics also merely represent another epistemological problem of calculating an immutably given equilibrium. However, the calculations involved here require
infinite information, which makes this into a problem of "effectively ontological"
uncertainty (Rosser, 1998).

PERSPECTIVES ON UNCERTAINTY AND EXPECTATIONS

557

the dynamics of the economic or social system, is bound to generate

local instability of self-fulfilling expectations, if the influence of expectations on the dynamics is significant." This would seem to represent the
very essence of the kinds of problems that Keynes had in mind when he
raised the problem of the interaction of peoples' expectations in his
"beauty contest" tale.
Conventions and bounded rationality in forming expectations

A close reading of Keynes suggests that people adopt conventions in the

face of uncertainty, with attempting to guess the expectations of others
playing a crucial role, until current conditions become such as to undermine the convention and the unpredictable extraordinary impinges upon
them and they must make "crucial" decisions that move things to a different zone. Such a view has recently been gaining ground broadly against
the extreme simplemindedness of the rational expectations hypothesis,
driven by a variety of factors, including many contained in the arguments listed above. Even Thomas Sargent (1993), one of the originators
of the rational expectations hypothesis, has declared that dynamic complexity implies bounded rationality. 12 An additional component of this
has been the increasing reporting of experimental economics studies
and studies from psychology showing that people focus upon their current environments and are susceptible to the views of those around them,
many of these involving so-called "anomalies" and "paradoxes" of behavior in which people rather clearly do not follow the predictions of
standard neoclassical theory (Kahneman et al., 1982; Thaler, 1994). These
studies further emphasize the fact that people do not have some higher
ability to form rational expectations by thinking and weighing all things
and options, but instead are attempting to learn from the behavior and
attitudes of those nearest to them and from the most dramatic or salient
events or phenomena that capture their attention, as they are unable to
understand everything. They are limited and bounded in what they can
perceive and understand.
Some Post Keynesians are unhappy with the idea of "bounded rationality," which is often associated with models in which people optimize
over the search for information in a world where there is a definite ergodic equilibrium and an objective probability distribution, which is
merely costly to learn about. However, it is clear that Keynes himself

12

See Sent (1996) for a critique of Sargent's views.

558 JOURNAL OF POST KEYNESIAN ECONOMICS

felt that agents would engage in "rational choice," subject to the information they had and the expectations that they formed, both of which
are clearly bounded inevitably. Following the argument that uncertainty
undermines rational expectations, Heiner (1983, 1989) argues that uncertainty actually induces predictable behavior as people adopt rules of
thumb, or conventions, when a gap emerges between their competence
to judge a situation and the difficulty of doing so. Others arguing for the
emergence of conventions in the face of uncertainty include Carabelli
(1988), de Carvalho (1988), and McKenna and Zannoni (1993)-a view
strongly supported in Chapter 12 of The General Theory (Keynes, 1936,
p. 152: "In practice we have tacitly agreed, as a rule, to fall back on what
is, in truth, a convention").
Even for the formation of these conventions within more or less routine situations, agents must assign "weights" to their observations based
on "epistemic reliability" (Gardenfors and Sahlin, 1982; Vercelli, 1991).
This may lead them to operate with mixtures of conventional probability estimates and conventions for uncertainty. In credit markets, these
can lead to models that involve both conventional asymmetric information and uncertainty (Dymski, 1994; Neal, 1996) that may imply financial fragility (Minsky, 1986) due to credit rationing. However, a variation
on this theme is that both borrowers and lenders facing fundamental
uncertainty leads to "asymmetric expectations" that can generate credit
rationing and other phenomena in credit markets that can generate macroeconomic fluctuations (Wolfson, 1996).
Ultimately, of course, Post Keynesians must face the implications of
the deep assertion of fundamental uncertainty by Keynes. Heiner's (1983,
1989) arguments are comforting in that people will fall back on rules of
thumb in moments of great uncertainty. But this is less useful when, ala
Shackle, it is the crucial decisions of people themselves that are bringing about the uncertainty. There is the threat invoked by Coddington of
a nihilism that cannot make any predictions even for policy. Davidson,
who has excoriated so many for not properly recognizing Keynesian
uncertainty, must also face this essential contradiction as he hopes for
the successful implementation of beneficial policy, which requires some
degree of forecasting and ergodicity. His response (Davidson, 1996, p.
506) is to invoke Reinhold Neibuhr's "'Serenity Prayer': God grant us
the grace to accept with serenity the things that cannot be changed (immutable realities), courage to change thiQgs that should be changed (mutable realities), and the wisdom to distinguish the one from the other."
This observer suspects that Keynes himself would have found the line
between these two to be uncertain.

PERSPECTIVES ON UNCERTAINTY AND EXPECTATIONS 559

Policy implications and conclusions

Keynes viewed probability as a fundamentally subjective concept that
depends on the logical relations between possible events. Given that
people base their expectations on the weightier of probable events that
they foresee as possible, and that those perceptions depend greatly on
what other people expect, expectations can change very suddenly and
the state of long-term expectation is fundamentally uncertain. With regard to probabilities themselves, Keynes distinguishes four cases: (i) that
there are no probabilities at all (fundamental uncertainty), (ii) that there
may be some partial ordering of probable events but no cardinal numbers can be placed on them, (iii) that there may be numbers but they
cannot be discovered for some reason, and (iv) that there may be numbers but they are difficult to discover.
Post Keynesians have drawn on these different viewpoints in forming
their views on the nature of uncertainty and expectations formation. One
line of argument emphasizes the element of potential surprise associated
with crucial decisions such as major capital investments. In this view,
fundamental uncertainty is equated with free will and choice by decision-makers. Followers of this line of argument also emphasize the unidirectional and irreversible nature of historical time. Another line argues
that the essence of fundamental uncertainty derives from nonergodicity
of time series and stochastic processes. Yet another emphasizes the nature of the interaction of people in forming expectations and various
complexities of group dynamics. In the face of this uncertainty, expectations are seen as arising from bounded rationality and conventions.
Many of these issues remain open to further research and debate with
Post Keynesians clearly offering important approaches, insights, and
perspectives. The fundamental nature of probability and stochastic processes may be the deepest such question that is far from closed. The
nature of how Keynesian uncertainty influences economic decision-making is another issue that could certainly see some further investigation.
The question of how complexity in the economic environment influences decision-making and whether or not this leads to uncertainty for
ontological or epistemological reasons is one that remains very controversial and unresolved. And the problem of how people actually form
expectations, what kinds of conventions they use, and how these interact with the institutional structure of the economy, is clearly an important one that Post Keynesians have much to offer in resolving. However,
one thing that is certain regarding the views of the various Post
Keynesians about Keynesian uncertainty and its implications for

560

JOURNAL OF POST KEYNESIAN ECONOMICS

expectation formation is that it is utterly incompatible with the rational

expectations hypothesis.
The Post Keynesian perspectives on uncertainty and expectations formation are central to the development of Post Keynesian views of macroeconomic policy. Of course, the rejection of rational expectations
coincides with a rejection of the "policy ineffectiveness" arguments of
the New Classical school. But, the arguments of the New Keynesian
school that emphasize the significance of sticky prices and wages are
also seen as inadequate as they too draw on rational expectations. Fundamental uncertainty is seen as implying the possibility of long-run unemployment, even in a world of perfect competition and fully flexible
prices and wages. Uncertainty leads to liquidity preference and the nonneutrality of money in the long run. Most importantly, uncertainty and
the associated instability of expectations is seen as underpinning the
instability of investment, which in tum is the main key to more general
macroeconomic instability.
The policy implications arising from these problems certainly include
active monetary and fiscal policies. But they also include deeper and
more fundamental institutional and structural changes in the economy.
Thus, Post Keynesians argue for the development of institutions that
can provide more general anchors for economic decision-making. Those
that have been suggested include various kinds of incomes policies to
stabilize the wage and price process, indicative planning to more broadly
coordinate expectations formation, and a variety of mechanisms to stabilize investment, including a more substantial role for government in
the process of investment.
There have been a variety of incomes policies suggested by many Post
Keynesian economists over the years. Prominent have been proposals
for tax incentive plans, wage incentive plans, full-blown wage and price
controls, or economy-wide "collective collective bargaining." All of these
involve a degree of direct government in the wage and price setting process, with tax breaks being given to industries that restrain prices or
wages and tax hikes facing those that excessively raise them. A marketoriented plan was proposed by Lerner and Colander (1980). Such plans
have not been implemented seriously anywhere. Wage and price controls have been used in many countries, but, except in wartime, seem to
break down after several years. Economy-wide wage bargaining, sometimes labeled "corporatism," has been extensively used in several Scandinavian countries and in Austria for extended periods of time, with
much success in terms of keeping down inflation while avoiding exces-

PERSPECTIVES ON UNCERTAINTY AND EXPECTATIONS 561

sive unemployment. A good discussion of this latter system and its actual functioning can be found in Pekkarinen et al. (1992).
Indicative planning has not always been associated with Post Keynesianism, although, as noted above, Keynes has long been thought to have
advocated it in certain of his writings. Advocacy of this approach, in
which government gets leading decision-makers together to jointly plan
expected growth, but without any command coercion to follow the plan,
has been more a feature of French Keynesianism. Although it has fallen
out of fashion to a large degree, indicative planning has been successfully used in the past in France, Japan, South Korea, and some other
countries, with India being a prominent ongoing practitioner. A discussion of French indicative planning can be found in Estrin and Holmes
(1983), while Meade (1970) provides a more general discussion within
a broader Keynesian context, and Frank and Holmes (1990) present it in
the context of a complex economy with multiple equilibria.
As regards government involvement in investment, this can cover a
range of possible activities, including subsidies or public works programs tied to business cycles, with Sweden having a fund for social
investment tied to the state of the economy, to a variety of more direct or
indirect methods of controlling investment, including more direct control of the banking system, although this can lead to the problem of
"crony capitalism," if managed poorly. Keynes spoke eloquently, if rather
vaguely, regarding this issue near the end of his General Theory (p. 378):
Furthermore, it seems unlikely that the influence of banking policy on
the rate of interest will be sufficient by itself to determine an optimum
rate of investment. I conceive, therefore, that a somewhat comprehensive
socialisation of investment will prove the only means of securing an approximation to full employment; though this need not exclude all manner
of compromises and devices by which public authority will co-operate
with private initiative. But beyond this no obvious case is made out for a
system of State Socialism which would embrace most of the economic
life of the community. It is not the ownership of the instruments of production which it is important for the State to assume. If the State is able to
determine the aggregate amount of resources devoted to augmenting the
instruments and the basic rate of reward to those who own them, it will
have accomplished all that is necessary.

Finally, for Post Keynesians more generally, overcoming the destabilizing tendencies arising from fundamental uncertainty in economic decision-making by whatever reasonable and appropriate means is probably
the central problem facing macroeconomic policymakers.

562 JOURNAL OF POST KEYNESIAN ECONOMICS

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