Expectations and the Economy

Virtually all economic behaviour and decisions depend on the decision-maker’s expectations about the future. Yet the future is unknowable, the expectations subjective; what then can an economist say constructively about them? The answer seemed to be, until quite recently: not a lot. The classical economists typically assumed either that expected future prices, and so on, were the same as current prices, or that they bore some mechanical relation to them (for example, changing by x per cent more of less). Ironically perhaps (in view of ultimate developments), it was in fact Keynes himself who first put expectations in the centre of the economic stage with a sort of theory attached: expectations of future profit and of future interest rates are crucial to Keynes’s theory of boom and slump, which still dominates modem business cycle thinking. Booms would occur when profit expectations were high and interest-rate expectations low; and vice versa for slumps. But Keynes could do little better in theorising about these expectations than to attribute profit expectations to the ‘animal spirits’ of businessmen and interest-rate expectations to stock-market prejudice. This is, quite transparently, an evasion. Hamlet, the Prince of the drama, is a deus ex machina, wheeled on and off inexplicably, even arbitrarily — decidedly not a ‘general’ theory.