However indebted to Keynesian economics, policymakers in the U.S. and Europe have rejected at least one of its key tenets: irreducible uncertainty.
According to biographer Robert Skidelsky*, Keynes believed that in many situations market participants “have no basis on which to calculate the risks they face in making an investment,” but are instead “plunging into the unknown.” Likewise, Keynes argued, no amount of competence or access to data on the part of policymakers can eliminate risk entirely.
The policymakers described by this article in today’s Washington Post, have, by contrast, set out to study so as to effectively control ‘systemic risk’ — particularly “run-ups in the prices of real estate or other investments, or a quick expansion of credit and lending.” Already, recommendations that central banks prevent future bubbles by controlling interest rates and raising capital requirements for banks are being floated, and a Financial Stability Oversight Council has been created as part of the financial reform bill.
In short, economic policymakers believe that market participants cannot be trusted to manage risk effectively, but the state can. Neoclassical economics stands on its head.
Supposing Keynes is correct in asserting that not all risk can be managed, however, it follows that policymakers have deceived themselves. At the same time, Keynes’ desire to have the state manage uncertainty — which he distinguishes from risk — seems questionable. According to Skidelsky, Keynes believed that
Risk could be left to look after itself; the government’s job was to reduce the impact of uncertainty. Risky activities, Keynes implies, should be left to the market, with entrepreneurs being allowed to profit from good bets and to suffer the consequences of bad bets. On the other hand, uncertain activities with large impacts should be controlled by the state in the public interest.
The phrase “irreducible uncertainty” used elsewhere by Skidelsky would seem to imply something along the lines of Donald Rumsfeld’s famous “unknown unknowns”; it implies that the state cannot safeguard the public interest based on a determination of which types of financial activities will have disastrous impacts and which won’t, since such a determination cannot possibly be made. Yet Skidelsky, building upon Keynes’ analysis, proposes to do just that through a reinstatement of Glass-Steagall and/or higher capital requirements on banks.
So what we have is a series of substitutions — systemic risk for the individual risk taken on by firms, and “uncertain activities with large impacts” for individual and systemic risk — each time with someone professing to be in control. Keynes comes closer than the policymakers described in the Washington Post article, but finally fails to admit that there are some things no one can control.
* All Skidelsky quotes taken from Keynes: The Return of the Master, highly recommended reading.