There seems to me to be no other economist with whose general way of thinking I feel myself in such genuine accord.
--Keynes to Commons, 1927
John Maynard Keynes and the Post Keynesians demonstrate that, in an uncertain and unknown world, economic agents prefer to retain money rather than make investment decisions. The consequence of this rational preference is the possibility of unemployment resulting from insufficiency of effective demand. Institutionalists believe that the "economic environment" has nothing to do with the notion of "equilibrium," as well as that money is a fundamental institution of the capitalist system because it affects the preferences and actions of economic agents. In both schools of thought, we can observe at least two essential aspects of the dynamic of contemporary economies. These are, first, that the economy is a historical process (which means that uncertainty matters) and, second, that institutions, both political and economic, are indispensable to the task of "modeling" economic events.
Considering the idea above, the Post Keynesian and institutionalist theories try to answer the following questions: How do economic agents make rational decisions? How do they form expectations? Why do they retain (or decide not to retain) money? Can the institutional environment influence economic decisions? If so, in what way? The answers to these questions lie in the concept of uncertainty linking the two schools of thought.
As is commonly known, uncertainty is the fundamental element of Keynes' theory. As Hyman Minsky wrote, to comprehend Keynes "it is necessary to understand his sophisticated view about uncertainty, and the importance of uncertainty in his vision of the economic process. Keynes without uncertainty is something like Hamlet without the Prince" (1975, 57). For institutionalists, in a world of incomplete and imperfect information institutions are necessary to force economic agents, with limited insights, to adopt strategies characterized by conventions.
This article aims at exploring the concept of uncertainty in the Post Keynesian and institutional economic theories. The concept of uncertainty is very important because it allows us to understand not only the instability of contemporary economies but, above all, the relevance of institutions in coordinating them. This implies that the article also analyzes the theoretical similarities between Post Keynesians and institutionalists on the social institutions related to money and the essential properties of money in an entrepreneur economy.
The article is divided into three sections. The first presents the concept of monetary economy developed by Keynes and the Post Keynesians. The idea is to show that individual expectations, so crucial to decision making, are directly related to a favorable institutional environment. The next section examines the idea of uncertainty in institutionalist theory. It also shows that, for institutionalists, money is an essential institution in the economic system. Finally, the third section, in terms of conclusion, links the two schools of thought, emphasizing the concept of uncertainty and the relevance of institutions.
Money and Uncertainty: The Essence of Keynes" Monetary Economy
Keynes' primary legacy consists in demonstrating the logic of a monetary economy. (1) In such an economy, fluctuations in effective demand and employment occur because, in a world in which the future is uncertain and unknown, individuals prefer to retain money, postponing consumption and investment decisions. As Keynes said, "booms and depressions are phenomena peculiar to an economy in which ... money is not neutral" (1973b, 411, emphasis added).
Why, in Keynes' economy, is money not neutral? In other words, how does retaining money protect against uncertainty regarding individual transaction and production plans? The explanation is in Keynes' General Theory of Employment, Interest, and Money (referred to below as GT).
In chapter 17 of GT, Keynes showed that money differs from other assets due to the following properties: first, the elasticity of money production is zero--that is, money is not produced by the quantity of labor the private sector employs in the productive process. Second, the substitution-elasticity of money is also zero. Third, the carrying cost of money is zero. These properties illustrate that money has two purposes in a monetary economy: it is a means of circulation--it facilitates exchanges-and it is a store of wealth.
Due to these properties, Keynes argued that "[u]nemployment develops, that is to say, because people want the moon;--men cannot be employed when the object of desire (i.e. money) is something which cannot be produced and the demand for which cannot be readily choked off" (1964, 235). In other words, unemployment occurs because, when the demand for money increases, the price of money is greater than the price of other producible assets.
Thus, by providing security against uncertainty, money links the past, present, and future, and, as a result, coordinates economic activity. In this sense, as Paul Davidson wrote, "in a world where people cannot reliably predict future ... the ... existence of money and money contracts over an uncertain future ... [are the bases] of a monetary system" (1994, 87). In other words, in a monetary economy, money is not neutral.
The principle of effective demand, essential to the Keynesian revolution, is based on the idea of non-neutrality of money. The insufficiency of effective demand occurs because individuals, in conditions of uncertainty, prefer to hold money or other liquid assets (2) instead of acquiring goods produced by labor. Thus, the liquidity preference--that is, money as an asset--inhibits economic agents' spending decisions and, as a result, it affects economic activity. In sum, by the principle of effective demand, economic crises come about because money is an alternative form of wealth.
The central question in Keynesian theory, therefore, concerns the relationship between uncertainty and money. Post Keynesian theory recovers this fundamental Keynesian insight: fluctuations in effective demand are related to the liquidity preference of individuals seeking safeguards against uncertainty. It is for this reason that Post Keynesians develop a theoretical structure in which the Keynesian revolution is studied within the context of a monetary theory of production (see, for example, Cardim de Carvalho 1992). In Keynes' words, in a monetary production economy "money plays a part of its own and affects motives and decisions and is, in short, one of the operative factors in the situation, so that the course of events cannot be predicted, either in the long period or in the short, without a knowledge of money between the first state and the last" (1973b, 408-409; emphasis added).
This quote not only illustrates the importance of money in monetary economies but also shows the relationship between money and uncertainty. In a monetary production economy, the concept of money's non-neutrality has to do with the decision process of economic agents amid uncertainty.
But what is uncertainty? In his 1937 article entitled "The General Theory of Employment," Keynes, responding to critics of the general theory, offered the following definition of uncertainty:
By "uncertain" knowledge, let me explain, I do not 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 .... Or ... 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.... About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know. (1973c, 113-114; emphasis added) On one hand, when Keynes said that roulette is not uncertain, he meant that for uncertain events probability cannot be obtained from relative frequencies. On the other hand, as an example of uncertainty, Keynes wrote that the price of copper twenty years from now is something nobody knows. From our point of view, Keynes argued that social, economic, and political conditions change radically over a twenty-year period, making it impossible to extrapolate future events based on the events of today. In other words, Keynes defined as uncertain a phenomenon whose probability" cannot be calculated, leaving people ignorant about the future.
The passage above provides us with the distinction between risk and uncertainty, suggested both by Keynes in A Treatise on Probability (1973a; referred to below as TP) and by Frank Knight in Risk, Uncertainty, and Profit (1921). Risk is a situation in which a decision must be made concerning a certain event and the probability distribution of this event is known. Uncertainty, on the other hand, characterizes a situation in which the probability distribution of the event does not exist. (3)
The 1937 article also illustrates the relationship between uncertainty and money: uncertainty is the main reason for the occurrence of liquidity preference and investment fluctuations. Keynes explained that "our desire to hold money as a store of wealth is a barometer of the degree of our distrust of our calculations and conventions concerning the future.... The possession of actual money lulls our disquietude; and the premium which we require to make us part with money is the measure of the degree of our disquietude" (1973c, 116; emphasis added).
If uncertainty cannot be modeled in a deterministic way in a monetary economy, the decisions of economic agents will be made according to conventions. Keynes wrote that "[i]t would be foolish, in forming our expectations, to attach great weight to matters which are very uncertain. (4) ... The state of...