Home > The Economics Profession > “Stiglitz implicitly accepts the orthodox view that . . .”

“Stiglitz implicitly accepts the orthodox view that . . .”

from Paul Davidson

My letter on the Stiglitz review of Robert Skidelsky’s Keynes: The Return of The Master is printed in the May 27, 2010 issue of the London Review of Books.

It reads as follows:

The Non-Existent Hand

Joseph Stiglitz criticises Robert Skidelsky, Keynes’s biographer, for not understanding Keynes’s theory, but in doing so reveals his own imperfect understanding (LRB, 22 April). The basis of his complaint is Skidelsky’s distinction between risk and uncertainty. Risk, Skidelsky explains, exists when the future can be predicted on the basis of currently existing information (e.g. probability distributions calculated from existing market data); uncertainty exists when no reliable information exists today about the future outcomes of current decisions, because the economic future can be created by decisions taken today. According to Stiglitz, this is a distinction without a difference, and ‘little insight’ into the causes of the Great Recession is gained from Skidelsky’s emphasis on uncertainty as opposed to risk.

But this is not what Keynes believed. The classical economics of Keynes’s time presumed that today’s economic decision-makers have reliable information regarding all future outcomes. I have labelled this the ‘ergodic axiom’. By contrast, Keynes argued that ‘unfortunate collisions’ occurred because the economic future was very uncertain. ‘By very uncertain,’ he wrote, ‘I do not mean the same thing as “very improbable”.’ No reliable information existed today for providing a reliable forecast of future outcomes.

This is the very proposition that Stiglitz denies. All that is needed to provide better insight into the workings of the market, he thinks, is ‘small and obviously reasonable change in assumptions’; for example, that reliable information about the future does exist but that different individuals have access to different information. The only necessary policy is ‘transparency’: to make complete information about the future available to all. The classical ergodic axiom is correct, provided one accepts that not everyone has access to all the information that exists.

For Keynes the inability of firms and households to ‘know’ the economic future is essential to understanding why financial crashes occur in an economy that uses money and money contracts to organise transactions. Firms and households use money contracts to gain some control over their cash inflows and outflows as they venture into the uncertain future. Liquidity in such an economy implies the ability to meet all money contractual obligations when they fall due. The role of financial markets is to assure holders of financial assets that are traded on orderly markets that they can readily convert these liquid assets into cash whenever additional funds are needed to meet a contractual cash outflow commitment. In Keynes’s analysis, the sudden drying up of liquidity in financial markets, occasioned by sudden drops of confidence, explains why ‘unfortunate collisions’ occur – and have occurred more than a hundred times in the last 30 years, according to Stiglitz.

By contrast, Stiglitz implicitly accepts the orthodox view that all contracts are made in real terms, as if the economy were a barter economy. Consequently people’s need for liquidity is irrelevant. Stiglitz indicates that he and Bruce Greenwald have explained that financial markets fail ‘because contracts are not appropriately indexed’, i.e., contracts in our economy are denominated in money terms rather than ‘real’ terms. He suggests that if only such contracts were made in real, rather than monetary, terms we would not suffer the ‘unfortunate collisions’ of economic crisis. If only we lived in a classical world, where contracts would be denominated in real terms! But in a money-using economy, this is impossible.

Paul Davidson
Journal of Post Keynesian Economics, New York

  1. May 23, 2010 at 1:47 am

    “… for example, that reliable information about the future does exist but that different individuals have access to different information.”

    This is quite simple assuming a falsehood. Reliable information about the present exists, though scattered across the population … reliable information about the future simply cannot exist until all of the strategic decisions that will help to determine future outcomes have been made.

    Certainly it may be the case that the mainstream economics can be pursued on the basis of assuming a falsehood that is slightly less false than the current falsehoods being assumed … but that is not science. Science is about trying to come up with cause and effect explanations about the problem at hand, and theorizing on the basis of the existence of reliable information regarding all pertinent points of interest regarding the future is coming up with cause and effect explanations regarding some other universe than the one we inhabit.

  2. Peter Radford
    May 25, 2010 at 6:13 pm

    I must admit I was also very disappointed in the Stiglitz review. He, like so many others, seems to overlook what I regard as a glaringly obvious feature of the world around us: uncertainty abounds. In fact uncertainty dominates. Not to integrate this into a theory of economics is senseless. To erect an intellectual superstructure to obviate the need to account for uncertainty is even worse: it is dishonest. That someone like Stiglitz prefers to ignore the centrality of uncertainty is astounding.

    In my view uncertainty is the reason that markets and businesses exist: they are devices to mediate from the present into the future in the face of uncertainty. By using such devices we invent narratives that limit the impact – within boundaries – that uncertainty can have on our decisions. This is an illusion, but a necessary one for exchange to take place. Sometimes our narrative matches the unfolding future well enough that uncertainty is, indeed, mitigated. Other times … not so much.

    Either way, the minor modifications Stiglitz advocates to the standard model, entirely miss the point.

  3. Peter T
    May 29, 2010 at 4:47 am

    All true. But, as Keynes realised and as Hicks pointed out in rejecting Keynes, to take on board uncertainty is to make economics incalculable. There is no mathematics of uncertainty. In short, the profession takes the view that it is better to be precisely wrong than vaguely right.

    • Alice
      July 10, 2010 at 11:55 am

      So true…and many who are precisely wrong spend a lot of time communicating in a new mechatechtronic language only their fellow academics understand. When was it exactly that the profession permitted the cessation of meaningful dialogue with ordinary native speakers….and rewarded only elaborately precise obscurity?

      • Peter Radford
        July 13, 2010 at 6:39 pm

        Not just obscure, Alice, but irrelevant. Plus, my impression is that most pursuits have become jargon infested over the last few decades. Economics is hardly alone in that regard. It’s almost as if we have become terrified of making simple, easily understood statements because they won’t be thought of as ‘clever’.

  4. Alice
    July 20, 2010 at 8:05 am

    Peter, I dont even trust the modern statistical packages…whats underneath? I gave one a trial with some long term historical data I had…I could have argued anything at all depending on which buttons I used. Not happy..meaningless twists and turns. Modern statistical packages can be used as political tools… if you can argue any which way you like.

    Irrelevant is right Peter – in the minutiae of their elaborate untrealistic models so prettily turned out by programs like STATA, and dutifully presented to heads of schools, earning a pat on the head for mediocrity and the aspiring student of electronic mathematics.

    How many of these gradgrinds actually thought, actually warned, actually foresaw, actually had the freedom of speech to actually warn policy makers at the highest levels to stop the current mess – to advise – to cure??

    It seems there are a multitude of mathematical pretenders digging away at the irrelevent – few with an eye to the bigger picture and the eloquence to speak about it.

    That is what the profession is missing.

  5. September 27, 2011 at 11:30 pm

    Paul, Bruce, Bravo & Kudos!!! Peter, Alice, I’m infinitely indebted to you both in the best way possible (spiritually, if you like). I started noticing the Rise of Mediocracy as a very young aspiring artist and it kept turning my stomach. Any else remember seeing absurdly self-important meta-intellectual gibberish under the titles of inane paintings in Important Galleries? then it became blatant, boldly ecocidal Demonocracy. So, now I’m a holontologist on a Mission, a Crusade to send residual Mediocracy and Demonocracy back to the abysmal oblivion from which they oozed. Will you join me? (at mm-greenbook. blogspot.com ) Thanks for the reminders & encouraging inspirations.

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