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Keynes on Monetary Policy, Finance and Uncertainty: Liquidity Preference Theory and the Global Financial Crisis (Routledge Studies in the History of Economics) ReviewThe author is correct that Keynes's theory of liquidity preference in the General Theory (1936;GT) is built on Keynes's theory of decision making in the A Treatise on Probability(TP;1921.See also Keynes's 1908 fellowship dissertation since practically the same material that forms the foundation of Keynes's approach in 1921 appears in 1908).The author is also correct that Keynes's theory of decision making combines his theory of probability and his theory of evidential weight.Unfortunately,the author does not know what Keynes's theory of probabiity entailed or what Keynes theory of evidential weight entailed.This review will thus concentrate on chapter four and especially pp.77-85.It is these pages that form the foundation for the authors's misbeliefs concerning the analysis contained in the TP as it relates to the GT's theory of liquidity preference.Nowhere in the book does the author demonstrate how Keynes operationalized his approach.He can't.The reason he can't is because he believes that Keynes did not make use of any numbers in his theoretical approach.This is due to his misbelief that Keynes's theories of probability/weight of the evidence were ordinal at best.Furthermore,the author follows the standard Post Keynesian belief that Keynes's theory could only be applied some of the time.This is, of course,identical to the Ramsey critique .Contrary to the author,Keynes's theory of probability primarily involved intervals using upper-lower probabilities .Keynes's approach ,based on the original Boolean logic contained in Boole's 1854 The Laws of Thought that Keynes modified and used in the TP,has been rediscovered unknowingly by Gilboa and Schmeidler.They use Choquet integration and inequality constraints ,formed using upper(concave) and lower(convex)capacities to demonstrate that nonlinear and non additive capacities are the general case.Keynes would agree while gentlely pointing out that he had already accomplished this feat in great mathematical detail in 1908 and in chapters 15,17,20 and 22 of the TP.The capacities approach is thus a footnote to the work of Keynes.
A specific example of Keynes's nomlinear and non additive approach of chapters 15,17,20,and 22 of the TP was worked out in great detail by Keynes in chapter 26 using his conventional coefficient of risk and weight ,c, on p.314 and in Footnote 2 on p.314.Edgeworth, in his 1922 article on " The Philosophy of Chance " in Mind ,was certainly correct for asking for the help of Mind readers to figure out the what and the why's involved in the application of Keynes's c coefficient.THis will be provided for the author below .
The foundation of Neoclassical economics is merely the mathematical development of a theoretical approach first proposed by Jeremy Bentham in 1787.Bentham claimed that all individuals have the capability to calculate the odds and outcomes and act on the expected value (the probability times the outcome) in a rational way.This can be expressed by the following ,where p is the probability of success and A is the outcome:
Maximize pA.
The modern version of this is to Maximize pU(A),where p is a subjective probability that is additive,linear,precise,and exact.U(A) is a Von Neumannn-Morgenstern Utility function.The goal is to
Maximize pU(A). The modern name for Benthamite Utilitarianism in neoclassical economics is SEU theory(Subjective Expected Utility).Therefore,a microeconomic foundation based on Utility Maximization is just Benthamite Utilitarianism updated with modern mathematical techniques.
BIbow is completely unaware about the reasons why Keynes rejected Benthamite Utilitarianism as a very special case that would only hold under the special assumptions of the subjectivist,Bayesian model-that all probabilities were additive,linear,precise,single number answers that obeyed the mathematical laws of the probabiity calculus.
Keynes specifies his conventional coefficient of risk and weight,c, model in chapter 26 of the TP on p.314 and fotnote 2 on p.314.Keynes then integrated his c coefficient into the elasticity analysis in chapter 21 of the GT,pp.304-306, in order to show that the standard Equation of Exchange was a special case of his generalized equation of exchange.The crucial elasticities,which play the role of w in Keynes's analysis in the GT,are e and ed subscript.These must equal 1 in neoclassical theory in the same manner that w must equal 1 in neoclassical theory.
Essentially, Keynes's generalized model is given by c=2pw/(1+q)(1+w),
where w is Keynes's weight of the evidence variable that measures the completeness of the relevant available evidence upon which the probabilities p and q are calculated.(Benthamite Utilitarians assume that the value of w is 1.)It is an index defined on the unit interval between 0 and 1,p is the probability of success,and q is the probability of failure.p+q sum to 1 if they are additive.This requires w=1.Keynes's c coefficient can be rewritten as
c=p [1/(1+q)][2w/(1+w)].
Now multiply by A or U(A).One obtains cA= p[1/(1+q)][2w/(1+w)]A.
The goal is to maximuze cA or cU(A).The weight 1/(1+q) deals with non linearity.The weight 2w/(1+w) deals with non additivity. It is now straightforward to see that the neoclassical microfoundations assume that all probabilities are additive and linear.This is nothing but a special case of Keynes's generalized decision rule to maximize cA,or cU(A),as opposed to the neoclassical pA or pU(A).It is now clear that Keynes had created general theories of macroeconomics,probability,and decision making.Keynes's accomplishments,if understood,place him as the only rival to Einstein for the title of the greatest scientist of the 20th century. However,Bibow understands none of this.
It was technically impossible for Bibow to accept Keynes's theories because Bibow, like Ramsey,Davidson ,and Runde ,accepted the standard frequency interpretation of probability view that all probabilities were linear,additive,precise,single number answers which were subject to the addition and multiplication rules of the probability calculus.It is impossible for Bibow to try to develop Keynes's approach because Bibow lacks a basic ,fundamental understanding of the nature of Keynesian probability.Keynes's views on subjective expectations , which were based on a w < 1 and probabilities that were non linear and sub or super additive,can makeno sense to Bibow.
Reasoning very similar to Bibow's accounts ,for example,for the Joan Robinson-G C Harcourt attack on Keynes's theory of investment and marginal efficiency of capital (MEC)as presented in chapter 11 of the GT and the Gay Meeks Ramseyian claims about Keynes's "Ordinal " theory of probability. Keynes's analysis was ultimately based on the c coefficient analysis of non additive,non -linear probabilities which Keynes presented in modified form in chapter 21 of the General Theory (1936) on pp.304-306 in the form of the elasticiites e and ed subscript.
Bibow's book does present a number of correct conclusions about Keynes's liquidity preference theory.He does demonstate the severe errors in the various loanable funds theories that he discusses in the book.However,NONE of his conclusions follow from his analysis,which fails abysmally to illustrate or show a single application of Keynes's decision theory.All loanable funds theories require the assumption of additivity and linearity to make sense because they must be premised on risk,as opposed to uncertainty and ambiguity ( D.Ellsberg's term for Keynes's different degrees of uncertainty where Ellsberg's rho index plays the same role as Keynes's weight of the evidence index,w.).Nowhere does BIbow draw this fundamentally important conclusion.All loanable funds theories REQUIRE that there be NO UNCERTAINTY about the future rate of interest.
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