by From Steve Keen The key concept in Keynes’s summary was the impact of expectations upon investment, when those expectations were about what might happen in an uncertain future. Investment is undertaken to augment wealth, and yet the outcome of any investment depends upon economic circumstances in the relatively distant future. Since the future cannot be known, investment is necessarily undertaken on the basis of expectations formed under uncertainty. Keynes was at pains to distinguish the concept of uncertainty from the simpler concept of risk. Risk occurs when some future event can only be one of a number of already known alternatives, and when there is a known history of previous outcomes which enables us to assign a reliable and definite probability to each possible outcome. A
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from Steve Keen
The key concept in Keynes’s summary was the impact of expectations upon investment, when those expectations were about what might happen in an uncertain future.
Investment is undertaken to augment wealth, and yet the outcome of any investment depends upon economic circumstances in the relatively distant future. Since the future cannot be known, investment is necessarily undertaken on the basis of expectations formed under uncertainty. Keynes was at pains to distinguish the concept of uncertainty from the simpler concept of risk.
Risk occurs when some future event can only be one of a number of already known alternatives, and when there is a known history of previous outcomes which enables us to assign a reliable and definite probability to each possible outcome. A dice roll is an example of risk. The dice can land only on one of six sides, and therefore only one of six numbers will turn up. If they are fair dice, each number has a 1 in 6 chance of turning up. The theory of probability can then be used to help predict the chances of various patterns of numbers occurring in future rolls of the dice.
Uncertainty is fundamentally different, and it has proved to be a difficult concept for economists before and after Keynes to grasp. Keynes gave several examples. Neither roulette, nor life expectancy, nor even the weather qualified. Instead, uncertainty referred to such things as the chance that war might break out (this was in 1937, not long before Chamberlain’s ‘peace in our time’ deal with Hitler), the rate of interest twenty years in the future, or when some invention would become obsolete. I gave a more positive and I hope evocative example of uncertainty in Chapter 8.
Probability theory cannot be used to help guide us in these circumstances because there is no prior history to go on, and because the outcomes are not constrained to any known finite set of possibilities. As Keynes put it, ‘About these matters there is no scientific basis on which to form any calculable probability whatever. We simply do not know’ (Keynes 1937: 214).