The General Theory of Employment Interest and Money - Keynes.pdf

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University of Massachusetts Amherst
ECON 104
Valerie Voorheiis

OF EMPLOYMENT INTEREST AND MONEY B\ JOHN MAYNARD KEYNES rtLLOKINGCOLLCAMIRlDGL NEW YORK HARCOUR?‘, BRACE AND COMPANY 148 THE GENERAL THEORY OF EMPLOYMENT BK V latter as being the state of long-/em eipectaLon;-as distinguished from the short-term expectation upon the basis of which a producer estimates what he will get for a product when it is finished if he decides to begin producing it to-day with the existing plant, which we examined in Chapter 5. It would be foolish, in forming our expectations, to attach great weight to matters which are very uncertain.’ It is reasonable, therefore, to be guided to a considerable degree by the facts about which we feel somewhat confident, even though they may be less decisively relevant to the issue than other facts about which our knowledge is vague and scanty. For this reason the facts. of the existing situation enter, in a sense dis- proportionately, into the formation of our long-term expectations ; our usual practice being to take the existing situation and to project it into the future, modified only to the extent that we have more or less definite reasons for expecting a change. The state of long-term expectation, upon which our decisions are based, does not solely depend, therefore, on the most probable forecast we can make, It also depends on the confidence with which we make this forecast-on how highly we rate the likelihood of our best forecast turning out quite wrong. If we expect large changes but are very uncertain as to what pre- cise form these changes will take, then our confidence will be weak. The stateof confidence, as they term it, is a matter to which practical men always pay the closest and most anxious attention. But economists have not analysed it carefully and have been content, as a rule, to discuss I By “ver * ” I do not mean the same thing as “very im- probable”.LYf.ty’ktisc on Probabiiip, chap. 6“The Lf’eight of Arguments”. . CH. 12 LONG-TERM EXPECTATION ‘49 it in general terms, _In particular it has not been made clear that its relevance to economic problems comes in through its important influence on the schedule of the marginal efficiency of capital. There are not two separate factors affecting the rate of investment, namely, the schedule of the marginal efficiency of capital and the state of confidence. The state of confidence is relevant because it is one of the major factors determining the former, which is the same , thing as the investment demand-schedule. There is, however, not much to be said about the state of confidence a priori. Our conclusions must mainly depend upon the actual observation of markets and business psychology. This is the reason why the ensuing digression ison a different level of abstraction from most of this book. For convenience of ex osition we shall assume in ’ the following discussion o Pthe state of confidence that * . i there are no changes in the rate of interest; and we 1 shall write, throughout the following sections, as if A changes in the values of investments were solely due to changes in the expectation of their prospective yields and not at all to changes in the rate of interest at which these prospective yields are capitalised. The effect of changes in the rate of interest is, however, easily superimposed on the effect of changes in the state of confidence. Ii1 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 ’ 73 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 r~cl THE GENERAL THEORY OF EMPLOYMENT BK, IV 1 ’ liner, a building in the City of London amounts to / little and sometimes to nothing; or even five years hence. In fact, those who seriously attempt to make any such estimate are often so much in the minority that their behaviour does not govern the market. In former times, when enterprises were mainly owned by those who undertook them or by their friends and associates, investment depended on a sufficient supply of individuals of sanguine temperament and con- structive impulses who embarked on business as a way of life, not really relying on a precise calculation of pro- spective profit. The affair was partly a lottery, though with the ultimate result largely governed by whether the abilities and character of the managers were above or below the average. Some would fail and some would succeed. But even after the event no one would know whether the average results in terms of the sums invested had exceeded, equalled or fallen short of the . prevailing rate of interest; though, if we exclude the exploitation of natural resources and monoIjolies, it is probable that the actual average results of investments, even during periods of progress and prosperity, have disappointed the hopes which prompted them. Busi- ness men play a mixed game of skill and chance, the average results of which to the players are not known by those who take a hand. If human nature felt no temptation to take a chance, no satisfaction (profit apart) in constructing a factory, a railway, a mine or a farm, there might not be much investment merely as a result of cold calculation. Decisions to invest in private business of the old- fashioned type were, however, decisions largely irrevoc- able, not only for the a whole, but also for the individual. With the separation between ownership and management which prevails to-day and with the development of organised investment markets, a new factor of great importance has entered in, which sometimes facilitates investment but sometimes adds CH. 12 L O N G - T E R M E X P E C T A T I O N *5* greatly to the instabiljty’of the system. In the absence of security markets, there is no object in frequently attempting to revalue an investment to which we are committed. But the Stock Exchange revalues many investments every dav and the revaluations pive a frequent opportunity to the individual (though “not to the community as a whole) to revise his commitments. It is as though a farmer, having tapped his barometer after breakfast, could decide to remove his capital from the farming business between IOand I Iin the morning and reconsider whether he should return to it later in 1 the week. But the daily revaluations of the Stock Exchange, though they are primarily made to facilitate transfers of old investments between one individual and i I another, inevitably exert a decisive influence on the rate of current investment, For there is no sense in build- ing up a new enterprise at a cost greater than that at which a similar existing enterprise can be purchased; whilst there is an inducement to spend on a new project what may seem an extravagant sum, if it can be floated off on the Stock Exchange at an immediate profit.1 Thus certain classes of investment are governed by the average expectation of those who deal on the i Stock Exchange as revealed in the price of shares, \ rather than by the genuine expectations of the pro- 1 fessional entrepreneure2 How then are these highly 1 significant daily, even hourly, revaluations of existing investments carried out in practice? 1 In my Trrarize on Money (vol. ii. p. 195) I pointed out that when a company’s shares are quoted very high so that it can raise more capital by issuing. more shares on favourable terms, this has the same effect as if it could borrow at a low rate of inteI should now describe this by saying that a high quotation for existing equities involves an increase in the marginal efficiency of the corresponding type of capital and therefore has the same efficiency of capital and the rate of interest) as a fall in the rate of interest. * This does not apply, of course, to classes of enterprise which are not readily marketable or to which no negotiable instrument closely corresponds. The categories falling within this exception were formerly Butensive. measured as a proportion of the total value of new investment they are rapidly declining in importance, 152 THE GENERAL THEORY OF EMPLOYMENT BKIV . IV Jn practice we have tacitly agreed, as a rule, to fall . , back on what is, in truth, a c~T h e. e s s e n c e o f this convention-though it does not, of course, work out quite so simply-l’res in assuming that the existing state of affairs will continue indefinitely, except in so far as we have specific reasons to expect a change, This does not mean that we really believe that the existing state of affairs will continue indefinitely. We know from extensive experience that this is most unlikely. The actual results of an investment over a long term of years very seldom agree with the initial expectation. Nor can we rationahse our behaviour by arguing that to a man in a state of ignorance errors in either direction are equally probable, so that there remains a mean actuarial expectation based on equi-probabilities, For it can easily be shown that the assumption of arith- metically equal probabilities based on a state of ignor- ance leads to absurdities. We are assuming, in effect, that the existing market valuation, however arrived at, is uniquely corvecrin relation to our existing knowledge of the facts which will influence the yield of the invest- ment, and that it will only change in proportion to changes in this knowledge; though, philosophically speaking, it cannot be uniquely correct, since our existing knowledge does not provide a sufficient basis for a calculated mathematical expectation. In point of fact, all sorts of considerations enter into the market valuation which are in no way relevant to the prospect- ive yield. Nevertheless the above conventional method of calculation will be compatible with a considerable measure of continuity and stability in our affairs, 50 long as we can rely on the maintenance ,of the convention, For if there exist organised investment markets and if we can rely on the maintenance of the convention, an investor can legitimately encourage himself with the CH. I2 LONG-TEl& EXPECTATION 123 idea that the only ‘risk he runs is that of a genuine change in the news over the neat future, as to the likelihood of which he can attempt to form his own judgment, and which is unlikely to be very large. For, assuming that the convention holds good, it is only these changes which can affect the value of his invest- ment, and he need not lose his sleep merely because he has not any notion what his investment’will be worth ten years hence. Thus investment becomes reasonably “safe” for the individual investor over short periods, and hence over a succession of short periods however many, if he can fairly rely on there being no breakdown in the convention and on his therefore having an opportunity to revise his judgment and change his investment, before there has been time for much to happen. In-xestments which are “fixed” for the community are thus made “liquid” for th~dividual~- ---It ~~beenl;l~~~re;-orrt)rt-b-asis-~fsome such procedure as this that our leading investment markets have been developed, But it is not surprising that a convention, in an absolute view of things so arbitrary, should have its weak points. It is its precariousness which creates no small part of our contemporary problem of securing sufficient investment, V Some of the factors which accentuate this precarious- ness may be briefly mentioned, I) As a’ result of the gradual increase in the pro- : portion of the equity in the community’s aggregate i capital investment which is owned by persons who do 1 not manage and have no special know1
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