On Uncertainty in Keynesian Macroeconomics and German Ordnungstheorie

Richter, Rudolf Article On Uncertainty in Keynesian Macroeconomics and German Ordnungstheorie Schmollers Jahrbuch – Journal of Applied Social Science Studies. Zeitschrift für Wirtschaftsund Sozialwissenschaften Provided in Cooperation with: Duncker & Humblot, Berlin Suggested Citation: Richter, Rudolf (2016) : On Uncertainty in Keynesian Macroeconomics and German Ordnungstheorie, Schmollers Jahrbuch – Journal of Applied Social Science Studies. Zeitschrift für Wirtschaftsund Sozialwissenschaften, ISSN 1865-5742, Duncker & Humblot, Berlin, Vol. 136, Iss. 2, pp. 131-153, https://doi.org/10.3790/schm.136.2.131 This Version is available at: https://hdl.handle.net/10419/292492 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ On Uncertainty in Keynesian Macroeconomics and German Ordnungstheorie* By Rudolf Richter** Abstract The debate on Keynes glossed over his intention to replace classical economic theory by an approach considering uncertainty in terms of there being no scientific basis on which to form calculable probability. Keynes takes this into account by replacing the (neo-)classical assumption of perfectly rational optimizing behavior by psychologically justified behavioral assumptions. As for the rest, he hangs on to the neoclassical model in a “macroeconomic”sense. Later developments based on the micro-foundations of macroeconomics disregard the Keynesian uncertainty problem entirely. Given that, Keynesians do not have much choice but to accept the older social control style of David Hume, also applied by German Ordnungstheorie (system theory) –and, indeed, there are no reasons for Keynesians to turn their backs on German Ordnungstheorie. JEL Codes: B22, B31, B52, D50, E20 1. Prologue Not being a historian of economic thought but only an aging economic theorist, I am naïve enough to take theoretical economic texts literally. Of course, I know that writings of great economists like John Maynard Keynes or Walter Eucken are understood by some of us as fundamentally cryptic texts that leave it to the reader to interpret what they mean. Both this view and my own are debatable. Both relate to how we understand economics –either as an empirical science (believing in empirically supported “cause-effect”style analysis) or as a philosophy (subject to the art of rhetoric). In this paper, I am applying the first, naïve perspective because it appears to be the best way to give the reader an idea of the issue under concern. Schmollers Jahrbuch 136 (2016), 131 –154 Duncker & Humblot, Berlin Schmollers Jahrbuch 136 (2016) 2 *I wish to thank Ulrich Schlieper (Mannheim), Dieter Schmidtchen (Saarbrücken) and two anonymous referees for their critical comments. ** Department of Economics, Universität des Saarlandes, Postfach 15 11 50, 66041 Saarbrücken, Germany. The author can be reached at r[email protected]. OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.136.2.131 | Generated on 2023-01-16 13:37:43 2. The Problem Keynes’General Theory (1973 [1936]) is, as Samuelson points out, “… a badly written book, poorly organized”(1947, 190). Still, it was a great success. But, as Samuelson adds, neither he nor anyone else in Cambridge, Massachusetts, knew what it was about for some 12 or 18 months after its publication. “Indeed, until the appearance of the mathematical models of Meade, Lange, Hicks, and Harrod there is reason to believe that Keynes himself did not truly understand his own analysis”(ibid., 188). Indeed, the image economists of the fifties or sixties had of Keynesian theory did not come from him but some of his interpreters among them, in particular, Hicks. The standard textbook models of the IS-LM type are based on Hicks (1937). How Keynes intended to answer his problem, however, remains a mystery. Also, what he intended to show is not precisely expressed. He says in his first chapter: “I shall argue that the postulates of the classical theory are applicable to a special case only and not to the general case, the situation which it assumes being a limited point of the possible positions of equilibrium”(Keynes 1973 [1936], 3). This claim brought about intense debate on what became known as the Keynesian theory of unemployment equilibrium. Less discussed –if at all – was, however, the Keynesian criticism of the classical assumption of perfect foresight that underlies the General Theory. Keynes refers specifically to this defect in his reaction to the first reviews of his book (Keynes 1973 [1937], 112). Certainly, he emphasized that the classical school –in the sense of the economics of Ricardo and his followers1–does not rule out risks but assumed them to be given “in a definite and calculable form.”In other words, classical theory presumed that uncertainty could be reduced “to the same calculable status as that of certainty itself.”Keynes adds that “[a]ctually, however, we have, as a rule, only the vaguest idea of any but the most direct consequences of our acts.”One of the most important economic activities would be that of the accumulation and administration of wealth. Indeed, “[t]he whole object of accumulation of wealth is to produce results, or potential results, at a comparatively distant, sometimes at an indefinitely distant, date”(ibid., 113). Thus, the classical approach would hardly work in a world in which investments “for an indefinitely postponed future”are important. In the case of (Knightian) uncertainty, there would be no scientific basis on which we could form any calculable probability whatsoever. In summing up Keynes writes: “I accuse the classical theory of being itself one of these pretty, polite techniques, which tries to deal with the present by abstracting from the fact that we know very little about the future”(ibid., 115). 132 Rudolf Richter Schmollers Jahrbuch 136 (2016) 2 1Including “… the followers of Ricardo, those, that is to say, who adopted and perfected the theory of Ricardian economics …” (Keynes 1973 [1936], 3, footnote 1). OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.136.2.131 | Generated on 2023-01-16 13:37:43 It would be this perspective that unavoidably leads classical economists to misleading judgments –in particular in their treatment of money and interest.2 This insight and his emphasis on the role of expectations is what authors like Hutchison describe as Keynes’ “most important fundamental contribution” (1980, 15). If “the future is not ours to see,”constrained optimization considerations are pointless. Thus, in his General Theory, Keynes replaces the assumption of the perfectly rational utility-maximizing man by psychologically justified behavioral assumptions. The three well-known fundamental psychological factors of Keynes are: the psychological propensity to consume (or save) the psychological attitude towards liquidity the psychological expectation of future yield from capital assets (Keynes 1973 [1936], 246 f.). Keynes almost fills half of his book with the description and explanation of these three fundamental psychological factors. They would determine the “effective demand”3at which the economy is in a specific Keynesian equilibrium. It is, thus, of interest to ask “what hypothetical psychological propensities would lead to a stable system; and then, whether these propensities can be plausibly described, on our general knowledge of contemporary human nature, to the world in which we live”(ibid., 250). From that angle the “Keynesian Revolution”consists of the substitution of the classic assumption of perfect individual rationality by psychologically explained behavioral assumptions facing imperfect individual knowledge of what the future will bring. As for the rest, Keynes adapts the mechanical style of the classical model dating back to Isaac Newton, etc.4 3. J. R. Hicks: “Mr. Keynes and the ‘Classics:’ A Suggested Interpretation” Alfred Marshall, who favored the distinction between short-run and long-run analysis, dominated the analytical style of reasoning of (English-speaking) economists at that time.5Hicks (1946) used this style of reasoning in his book On Uncertainty in Keynesian Macroeconomics 133 Schmollers Jahrbuch 136 (2016) 2 2“Being based on flimsy foundations, expectations of the future are subject to sudden changes”(Keynes 1973 [1937], 114). 3“… the aggregate income (or proceeds) which the entrepreneurs expect to receive … from current employment which they decide to give“(Keynes 1973 [1936], 55). 4See Richter (2015, chapters 2 and 10). 5Actually Keynes distanced himself early on from long-run analysis. Frequently referred to is his remark: “in the long run we are all dead”(Keynes 1923, chapter 3). OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.136.2.131 | Generated on 2023-01-16 13:37:43 Value and Capital. There he explained –in his own way –general equilibrium theory to mainly English-reading economists of what at this time had only been published in French or Italian. As a by-product, he became the leading interpreter of Keynesian Economics with his IS-LM diagram. His elegant presentation is still today standard-fare in introductory macroeconomics textbooks. In Value and Capital, Hicks translated the General Equilibrium Theory of Léon Walras and Vilfredo Pareto into what he calls temporary equilibrium theory. His unit of time –the short period –is the “Hicksian Week”within which everybody is perfectly informed, and only spot transactions are effected (Hicks 1946, 140). It is, so to speak, an out of focus “present”(in which everybody is fully informed about everything). Economic dynamics consists of a series of such (dated) temporary equilibria –so to speak a sequence of stationary images of short-term equilibria –like the pictures on a filmstrip. This style of reasoning –related to one week instead of a point of time –is sufficiently blurred to disguise the involved information problem. Within the “Hicksian Week”(or at that moment), actors are both waiting for the result of the Walrasian tâtonnement process and fully informed about commodities, prices, etc. In this respect, there exists neither risk nor uncertainty. They are a problem only with respect to the future (the weeks after each on-going “Hicksian Week”). But even then, Hicks assumes, different from Keynes, “… that people expect particular definite prices, that they have certain price-expectations.”(ibid., 126).6Hicks concludes: “By the device of definite expectations, we are enabled to use the same analysis as in statics to set out the equilibrium of the private individual and the firm, to determine the dependence of plans on current prices and expected prices. Taking this together with the fact that we have preserved the concept of market equilibrium, the essentials of static analysis are still available to us”(ibid., 127). The model of temporary equilibria is the simplest case of quasi-dynamic period analysis. Changes in the stock of productive capital are neglected; wages, prices, and interest rates reach their equilibrium value immediately (within the “Hicksian Week”in which all spot prices are negotiated by some tâtonnenent process). In this sense the model is always in equilibrium, there always exists full employment (see Leijonhuvfud 1968, 50 ff.). Thus, this model cannot explain the Keynesian problem of underemployment equilibrium. A simple way out is to assume prices and wages to be “sticky,”i.e., assuming they are fixed in the short term (i.e., within the “Hicksian Week,”which is a sufficiently blurred concept for that purpose). Assume now that the system is disturbed by an unexpected change in, say, autonomous investments I a .In that 134 Rudolf Richter Schmollers Jahrbuch 136 (2016) 2 6Hicks continues: “But we shall be prepared on occasion to interpret these certain expectations as being those particular figures which best represent the uncertain expectations of reality.” OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.136.2.131 | Generated on 2023-01-16 13:37:43 case, it may be plausibly assumed that firms adapt supply of products and demand for labor with their feasible sales (net social product Y), and similarly that consumers observe the level of their realized (national) income (Y). Investments would continue to be determined by the interest rate i. Demand and supply of consumer goods and labor services are in this case no more controlled by wages and prices but by national income Yor “effective demand.”As a consequence unemployment and (temporary)equilibrium in the (aggregate) commodity market are compatible, making underemployment equilibrium feasible. The Hicksian IS-LM diagram represents the solution to the underlying system of two equations in the two variables Yand igraphically. Consumption is determined by the absolute income hypothesis C(Y), investment demand by the nominal interest I(i). Both variables also determine desired cash balances. Among the givens are the supplies of money and labor in addition to “sticky” commodity prices and wages.7 Even easier than the IS-LM diagram is the interpretation of Keynes’sGeneral Theory by assuming given not only prices and wages but also interest rates – and thus investment demand I n . In that case, the Hicksian model is reduced to one equation in one unknown, (real) national income Y. The equilibrium level of Yrepresents what Keynes calls effective demand. If Y f denotes national income at full employment (our policy target), and if we add to our equation another variable –government expenditures Gas our policy instrument –we may read it as an equation that determines government expenditures G = G f at full employment income Y f .8That is a still crazier idea for classical economists. It played a central role in the debate on Keynes’sGeneral Theory. This model underlies the famous theory of the investment multiplier. All one needs to do to achieve full employment is to extend Gto a small fraction of the required increase in Y. This simple model was enthusiastically absorbed by engineers, like by Carl Föhl (1955) in Germany, who presented it in the form of a flow diagram. Coddington (1976) dubbed this interpretation “hydraulic Keynesianism.”To this day, it is living on in public debates (sadly, also by the Economist (Anon. 2015a, 14)9in its critique of Chancellor Merkel’s austerity policy towards Mediterranean Eurozone members). On Uncertainty in Keynesian Macroeconomics 135 Schmollers Jahrbuch 136 (2016) 2 7The IS-LM Diagram is an early description of what Samuelson in the 1955 edition of his Economics calls the “neoclassical synthesis”[of microand macroeconomics]. The mature synthesis is discussed in Samuelson (1967). See also, (Goodfriend and King 1997, 233, footnote 1). 8C(Y f ) + I n + G = Y f . 9See the subsection “Spend, Spend, Spend.” OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.136.2.131 | Generated on 2023-01-16 13:37:43 4. The Micro-Foundations of Macroeconomics Neoclassical economics tends to devour its enemies. Unsurprisingly, not before too long the call for the micro-foundations of macroeconomics sounded. It was put into practice disregarding Keynes’s criticism “that we know very little about the future”(1973 [1937], 115). It returned to elements of neoclassical economics but stuck to Keynesian process analysis, and assumed the shape of two types of analysis: a) Disequilibrium Analysis based on Clower’s “dual decision hypothesis”(1965, 118). Clower argued that if the price mechanism stops working, consumers switch to “quantity rationing.”Malinvaud (1977, 4 f.) extended the idea, assuming that aggregate consumers maximize their utility subject to their present (national) income Y. Similarly, aggregate firms maximize their profits subject to aggregate employment N.10 The adjustment process of “disequilibrium theory”is copied from the Walrasian tâtonnement process with quantities being called out instead of prices (Grandmont (1977, 175); Benassy (1975, 504 and 509). From that perspective, Keynesian disequilibrium analysis becomes “temporary equilibrium analysis with quantity rationing”(Malinvaud 1977, 4). However, the resulting macro-model turned out to be rather clumsy, cumbersome to teach and unsuited for econometric analysis. b) The “New Keynesian Macroeconomics,”surveyed by Romer (1993) and others.11 It returns to elements of classical economics though it sticks to Keynesian process analysis. The classical hypothesis of perfect foresight is replaced by the assumption of rational expectations12 or other hypotheses on the formation of expectations combined with suitable propositions on the constrained optimization of utility (for households) resp. profits (for firms), and assumptions on market imperfections such as “staggered prices”(Calvo 1983). It gave rise to the development of the “New Neoclassical Synthesis”(NNS) as described by Goodfriend and King (1997), which became the ruling model underlying today’s monetary policy. The economy is described by some kind of Walrasian 136 Rudolf Richter Schmollers Jahrbuch 136 (2016) 2 10 The problem of consumers and producers is answered (or better ignored) by Samuelson’s“honest method”(1947, 144). That is, aggregate commodities, services, financial assets are seen as one homogenous good or one financial title, etc.; aggregate firms are treated as one firm, aggregate consumers as one consumer, etc. 11 For a textbook-style presentation see Walsh (2003, 232 –256). 12 Yet the hypothesis of rational expectations does not answer the Keynesian problem that we “simply do not know”what the future will bring. It is no more than “…the predictions of the relevant economic theory”(Muth 1961, 316 f.). OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.136.2.131 | Generated on 2023-01-16 13:37:43 general equilibrium theory polluted by assumptions on imperfect competition and imperfect foresight.13 They are key features of models like the new FRB/ US Macroeconomic Model (Brayton et al. 1997). Goodfriend and King characterize the New Neoclassical Synthesis model of the USA as follows: “The New Neoclassical Synthesis inherits the spirit of the old, in that it combines Keynesian and classical elements. Methodologically, the new synthesis involves the systematic application of intertemporal optimization and rational expectations as stressed by Robert Lucas. …Moreover, the new synthesis also embodies the insights of monetarists, such as Milton Friedman and Karl Brunner, regarding the theory and practice of monetary policy …The New Neoclassical Synthesis (NNS) suggests a set of major conclusions about the role of monetary policy. [Viz., that it can have first] … an important effect on real economic activity …Second, …,the model suggests little long-run trade-off between inflation and real activity. Third, the model suggests significant gains from eliminating inflation …Fourth, the model implies that credibility plays an important role in understanding the effects of monetary policy …The new synthesis …implies a monetary policy regime of inflation targets, which vary relatively little through time”(1997, 232). The “New Keynesian Macroeconomics”keeps within the limits of neoclassical economics with perfect foresight, and sticks to the Hicksian two-period world of “today”and “tomorrow.”14 In the world of Patinkin “… all goods of the economy [are divided] into four composite categories: labor services, commodities, bonds,15 and money. To each of these categories, there corresponds a market, a price, an aggregate demand function, and an aggregate supply function”(1965, 199). Patinkin continues, adding that “[t]here are four markets. For each market, there are three equations: a demand equation, a supply equation, and an equilibrium equation, etc.”He resumes, noting that “[b]y Walras’Law, only three of these equations are independent.16 Correspondingly, there are only three unknown variables to be determined: the money wage rate, the price level, and the rate of interest”(ibid., 228 f.). Because of Walras’Law, one of the four equations is dropped, usually the bonds equation, i.e. the equation characterizing the “capital market”or market for financial assets besides money. It is at this at which Minsky directs his criticism. He writes: “Neoclassical price theory is limited to explaining how relative prices of currently produced goods adjust so that markets are cleared; the financial and capital-asset On Uncertainty in Keynesian Macroeconomics 137 Schmollers Jahrbuch 136 (2016) 2 13 This would exclude the possibility of insurance contracts and allow an efficient risk distribution through the market as described by Arrow (1953) in his time-state-preference theory. 14 Not mentioned are Arrow’s time-state-preference theory and the problem of efficient risk allocation. 15 Or, in general, financial assets aside from money. 16 For more on Walras’Law, see Lange (1942, 50). OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.136.2.131 | Generated on 2023-01-16 13:37:43 price-validating relations that must be satisfied if the economy is to be coherent are ignored”(1986, 141). In fact, the occasional instabilities of financial markets are the sore point of capitalism as illustrated by the Great Depression or the Financial Crisis of 2007/08. Incomplete foresight or fundamental uncertainty play a vital role in this context. This is to be noted when returning to Keynes’General Theory and its behavioral assumptions, which Keynes superimposed onto neoclassical economics models, and is closely linked to Newton’s celestial mechanics (Richter 2015, chapter 10). Interestingly, much knowledge in macroeconomics is not required. Elementary business knowledge or experiences are sufficient, such as when the Economist (Anon. 2015b, 75) writes “… when the central bank cuts interest rates to stimulate the economy, the newly created credit may well be used not to buy new assets, but to buy existing properties. The result may be a speculative bubble …” Da capo al fine. It would also have helped to consider possible consequences of the textbook example of the Keynesian “liquidity trap.”17 5. Two Different Approaches Two fundamentally different analytical approaches are apparent: (a) Starting from an assumption that the research object of economics is an ergodic world for which history does not matter, and sticking to neoclassical microeconomics with the restriction that its celestial mechanics do not necessarily lead to general equilibrium. The criterion of “efficiency”is the condition of constrained optimization. (b) Starting from the opposite assumption that economics deals with a non-ergodic world for which history does matter. For that world, celestial mechanics do not function as an analytical technique –a way out is to use a different methodology, namely that of social control. The criterion of “efficiency”is the ability “of rapid adaptation to changes in the particular circumstances of time and place”(Hayek 1945, 524). North (1990, 80) speaks of “adaptive efficiency”of organizations or institutions. Regarding (a): The Economy Is an Ergodic World for which History Does Not Matter18 In spite of his claim that price competition may lead to under-employment equilibria, Keynes sticks to elements of neoclassical microeconomics, imply138 Rudolf Richter Schmollers Jahrbuch 136 (2016) 2 17 A textbook term, the problem is raised in Keynes’General Theory (1973 [1936], 207). OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.136.2.131 | Generated on 2023-01-16 13:37:43 Discussion: Taylor follows the majority opinion of the Financial Crisis Inquiry Report (2011),40 which according to Wallison suggests “that the crisis could have been avoided if the private sector had not taken so many risks and government regulators had not been asleep at the switch”(2011).41 Like most Keynesians,42 he argues as if the economy were a machine, more recently even with agents equipped with artificial intelligence (cf. Sargent 1995).43 It is in this line of thought that the achievement of “high employment level”and “steady and appropriate economic growth”44 are credited to the state by its interest rate policy, deficit spending, bailouts of banks, financial regulations, etc. The evolving bailout mentality gave impetus to studies on questions of social control, such as, How Bankruptcy Reform Can End ‘Too Big to Fail.’45 Since business fluctuations or financial crises are the flipside of capitalism, and since the legal framework of the economy –its “economic order”or constitution –plays a vital role, it seems obvious to at least extend Keynesian “quantitive economic policy”by aspects of German Ordnungspolitik, i.e., by keeping an attentive eye on the existing social control mechanism and how it could be improved. Practitioners of economic policy all over the world likely do this anyway. So why not elevate this style of reasoning into the higher world of science? This brings us to the next subsection: 6.2 The Hume/Smithian Perspective Wallison’s presentation of the financial crisis of 2007/08 looks like a textbook example of German Ordnungstheorie.46 He stresses the role of “affordable housing policy”and argues that while banks originally were required to use safe and sound lending practices, the “affordable housing goals”required them to become “innovative”or “flexible”in the granting of credit to low and On Uncertainty in Keynesian Macroeconomics 145 Schmollers Jahrbuch 136 (2016) 2 40 See Financial Crisis Inquiry Report (2011). 41 The Financial Crisis Inquiry Report (2011, xv–xxviii) is certainly more detailed; it enumerates eight reasons. 42 “Keynesians”referred to here in a general sense. I myself followed in my lectures on macroeconomics –what is now called –the Neo-Keynesian view. See Richter et al. (1981). 43 Sargent proposes to build models “with boundedly rational agents …by expelling rational agents from our model environments and replacing them with ‘artificially intelligent’agents who behave like econometricians. These ‘econometricians’theorize, estimate, and adapt in attempting to learn about probability distributions which, under rational expectations, they already know”(Sargent 1995, 3; emphasis added). That is, Sargent assumes that his agents know all relevant stochastic variables. There exists no fundamental uncertainty, which explains Lucas’optimism. 44 See the German Gesetz zur Förderung der Stabilität und des Wachstums der Wirtschaft (StWG), of June 8 1967. 45 See Scott et al. (2015). 46 This paragraph relies heavily on Wallison (2009). OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.136.2.131 | Generated on 2023-01-16 13:37:43 moderate income borrowers. These looser standards soon spread to the credit markets that vastly increased the availability of credit for mortgages. Wallison continues that this caused speculation in housing, which ultimately led to the bubble in housing prices. Rising house prices concealed the basic problems for years. But after house prices stopped rising, the damage done by relaxed loan standards was revealed. In addition, state-based residential finance laws gave homeowners too free options that contributed substantially to the financial crisis. Thus, any homeowner could, without penalty, refinance a mortgage whenever interest rates fell or home prices rose to a point where there was significant equity in the home, enabling them to extract any equity that had accumulated between the original financing transaction and any subsequent refinancing.The result was so-called cash-out refinancing, in which homeowners were able to use their homes like savings accounts, drawing out funds to buy cars, boats, or second homes. Furthermore, different from German mortgage law, most states in the United States allow the designation of mortgages as being “without recourse.”That means, in essence, “… defaulting homeowners are not personally responsible for paying any difference between the value of the home and the principal amount of the mortgage obligation, or that the process for enforcing this obligation is so burdensome and time-consuming that lenders simply do not bother. In other words, such homeowners could walk away from their ‘underwater’mortgages”(Wallison 2009). Of course, there were also “… greedy investment bankers; incompetent rating agencies; irresponsible housing speculators; shortsighted homeowners; and predatory mortgage brokers, lenders, and borrowers –all played a part, but they were only following the economic incentives that government policy laid out for them.”Wallison concludes: If we are really serious about preventing a recurrence of this crisis, rather than increasing the power of the government over the economy, our first order of business should be to correct the destructive housing policies of the U.S. government (ibid.).47 Discussion: Wallison’s analysis comes close to the arguments of German Ordnungspolitik. That is not surprising, since they are near replicas of the principles of classical British economics, though, with one important exception: Eucken’s maxim is that the establishment of the economic constitution (or order) must not to be left to laissez-faire.48 Today, this axiom can be justified as following by Olson’s theory of collective action (1965): developed markets are collective goods.49 That is true in particular of financial markets whose traded 146 Rudolf Richter Schmollers Jahrbuch 136 (2016) 2 47 According to the Economist, not much has happened so far. The article concludes: “… until America’s mortgage monster [worth $26 trillion –more than America’s stock market] is brought to heel, the task of making finance safer will remain half done” (Anon. 2016). 48 Which corresponds at least to the “Austrian”reading of British classical economic principles (see Menger 1963 [1883]). OPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.136.2.131 | Generated on 2023-01-16 13:37:43 products are difficult to monitor50 and where money claims are difficult to enforce. Akerlof’s lemons principle raises its head, entailing “the incentive to originate and sell low-quality claims that may (and, in fact, did) end up as lemons or ‘toxic assets’” (Richter 2009). –But “… not all risks which it would be desirable to shift can be shifted through the market”(Arrow 1970, 139).51 Financial markets are more or less incomplete, which can be allowed for by either suitable debt contracts or by non-market constructs such as financial firms, private or public regulation, bankruptcy law, etc. (see Arrow 1970, 141). As for the latter, financial firms may be understood as organizational answers to transaction costs, imperfect foresight, and bounded rationality. They comprise contracts between a collectivity of actors (firm owners and staff) whose governance structure (organization) allows them to react effectively to unforeseen events (see Williamson 1985, chapter 3). Financial firms are led by financial entrepreneurs in the sense of Frank Knight (1921), i.e. by people who can deal with the consequences of unforeseen events. They prided themselves as inventors or first users of complex, headache-causing, difficult to enforce financial innovations “such as securitized bank loans,collateralized debt obligations (CDOs) or credit default swaps (CDSs). As any novelty, financial innovations are not necessarily beneficial. Thus, the introduction of unregulated CDOs and CDSs led to a remarkable increase in opportunism (moral hazard) among their originators and traders,52 which contributed to the extent of the 2008 crisis and resulted in the enormous complexity of their liability structure”(Richter 2015, 106).53 On Uncertainty in Keynesian Macroeconomics 147 Schmollers Jahrbuch 136 (2016) 2 49 See Richter (2009). Collective goods may be public or private. A private collective good would be a club good in case of a closed market or a private public good in case of an open market –similar to Coase’s (1974) lighthouse example. The decline of the provision of privately ordered public goods may be the result of badly governed principalagent contracts between today’s capital owners and their agents (their “salaried executives and their salaried managers and sub-managers”). Schumpeter speaks in this context of the erosion of ownership interests (1942, 141). It is tempting to illustrate the wealthdestroying consequences of such an employee-run capitalism by the fallout of the financial crisis of 2008. 50 “… an opaque web of interconnected obligations”(Brunnermeier 2009, 98) is far removed from Eucken’s constituent principle of liability. 51 Arrow puts the problem as follows: “What we observe is that the failure of the price system to handle risk-bearing adequately leads to a diminished use of prices even in contexts where they would be most useful in bringing about a careful and flexible confrontation of needs and resources”(1970, 141). 52 See Wagner (2009). 53 See Scott (2009) who describes the complexity of CDOs and adds: “About 80% of the 2.5 trillion subprime mortgages made since 2000 went into securitization pools.”By way of illustration he adds an example of a CDO 2 created by a large bank in 2005. “It had 173 investments in tranches issued by other pools […] It issued 975 million of four AAA tranches, and three subordinate tranches of $55 million. […] Two of the 173 investments […] were tranches from another billion-dollar CDO […], which was comOPEN ACCESS | Licensed under | https://creativecommons.org/about/cclicenses/ DOI https://doi.org/10.3790/schm.136.2.131 | Generated on 2023-01-16 13:37:43 7. Concluding Remarks The debate on Keynes glossed over his intention to replace classical economic theory by an approach considering the fact of uncertainty in the sense of insurmountable limited foresight. He tried to overcome this problem by introducing behavioral assumptions on consumption, investment, and cash management. He enriched economics by revitalizing the circular flow concept and by his suggestion to think in simple aggregates that also helped to develop national and financial accounting. However, the “New Neoclassical Synthesis”that evolved from Keynes’sGeneral Theory keeps within the limits of neoclassical economics and is closely linked to Newton’s celestial mechanics (Richter 2015, chapter 10). 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