Uncertainty, Expectations, and The Future: If We Don’t Know the Answers, What Are the Questions?

Abstract

Expectations about the future are critical in the study of economics. The belief in the existence of the future explains why agents engage in activities such as saving and investment, why they are willing to make loans, and why they are willing to accept intrinsically worthless money in exchange for goods and services. The future would matter even if it were known with complete certainty, but the fact that it is known only withuncertainty, if it is known at all, makes its representation and effects even more complex. Keynes was one of the first economists to emphasize the significance of the uncertain nature of the future, and in his 1937 Quarterly Journal of Economics article defending The General Theory, uncertainty about the future assumed a central role. Within the Keynesian model, uncertainty about the future enabled fluctuations in investment spending and liquidity preference, both of which are behaviors intrinsically related to the future that could occur autonomously and independently of current objective circumstance. This cnrtical interaction between uncertainty and expectations therefore enabled autonomous fluctuations in aggregate demand, and in doing so elevated the importance of expectations in Keynesian economics. Recently, expectations have again been at center stage in economics, this time in the form of the rational expectations (RE) hypothesis associated with New Classical macroeconomics (NCM). RE has shifted the focus of interest away from the Keynesian concern with the effect of expectations about an uncertain future on investment spending and liquidity preference, to the effect of expectations on the real conse