Keynes Seminar 4 February 2009 Mark Hayes Robinson College, Cambridge General Theory Reading Group 6: Aggregate Demand II: The Dark Forces of Time and Ignorance © PKSG 2009

Time and Ignorance The outstanding fact is the extreme precariousness of the basis of knowledge on which our estimates of prospective yield have to be made. Our knowledge of the factors which will govern the yield of an investment some years hence is usually very slight and often negligible. If we speak frankly, we have to admit that our basis of knowledge for estimating the yield ten years hence of a railway, a copper mine, a textile factory, the goodwill of a patent medicine, an Atlantic liner, a building in the City of London amounts to little and sometimes to nothing; or even five years hence. (G.T. 149)

Time and Ignorance 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, 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 20 years hence, or the obsolescence of a new invention, or the position of private wealth owners in the social system in About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know. (C.W. XIV, pp. 113–4)

Fundamental value

Keyness and Classical probability

Conventional value

Time and Ignorance We should not conclude that everything depends on waves of irrational psychology. On the contrary, the state of long-term expectation is often steady. Thus after giving full weight to the importance of the influence of short-period changes in the state of long-term expectation as distinct from changes in the rate of interest, we are still entitled to return to the latter as exercising, at any rate, in normal circumstances, a great, though not a decisive, influence on the rate of investment. (G.T. 162)

Kaldor on Keyness liquidity Mr Keynes, in certain parts of The General Theory appears to use the term liquidity in a sense which comes very close to our concept of perfect marketability; ie goods which can be sold at any time for the same price, or nearly the same price, at which they can be bought. Yet it is obvious that this attribute of goods is not the same thing as what Mr Keynes really wants to mean by liquidity. Certain gilt-edged securities can be bought on the Stock Exchange at a price which is only a small fraction higher than the price at which they can be sold; on this definition therefore they would have to be regarded as highly liquid assets. In fact it is very difficult to find satisfactory definition of what constitutes liquidity – a difficulty, I think, which is inherent in the concept itself. (Kaldor, 1939, p. 4, n5)

Keynes on liquidity In [a non-monetary] economy capital equipments will differ from one another (a) in the variety of the consumables in the production of which they are capable of assisting, (b) in the stability of value of their output (in the sense in which the value of bread is more stable through time than the value of fashionable novelties), and (c) in the rapidity with which the wealth embodied in them can become liquid, in the sense of producing output, the proceeds of which can be re-embodied if desired in quite a different form. (G.T. 240)

Keynes on liquidity … there is a further decision which awaits him, namely, in what form he will hold the command over future consumption which he has reserved, whether out of his current income or from previous savings. Does he want to hold it in the form of immediate, liquid command (i.e. in money or its equivalent)? Or is he prepared to part with immediate command for a specified or indefinite period, leaving it to future market conditions to determine on what terms he can, if necessary, convert deferred command over specific goods into immediate command over goods in general? (G.T. 166)

Keynes on liquidity In [a non-monetary] economy capital equipments will differ from one another (a) in the variety of the consumables in the production of which they are capable of assisting, (b) in the stability of value of their output (in the sense in which the value of bread is more stable through time than the value of fashionable novelties), and (c) in the rapidity with which the wealth embodied in them can become liquid, in the sense of producing output, the proceeds of which can be re-embodied if desired in quite a different form. (G.T. 240)

The hierarchy of liquidity

Changes in international equity prices since 4 January 2005 (a) as of August 2008 Inflation Report Source: Thomson Datastream. (a) In local currency terms.

Updated as of November 2008 Inflation Report Sources: Bloomberg and Thomson Datastream. (a) In common currency (US dollar) terms.

Sterling three-month interbank rates relative to future expected policy rates (a) – November 2008 Inflation Report Sources: Bloomberg and Bank calculations. (a) Three-month Libor spread over equivalent-maturity overnight interest rate swaps. Dashed lines show forward spreads derived from forward rate agreements and are based on the fifteen working day averages to 6 August 2008 and 5 November 2008 respectively.

Next time: Geoff Tily HM Treasury Keynes, Policy and The General Theory 11 February 2009