Role of Expectations and Hicks’ Analysis

Read this article to learn about the role of expectations and Hicks’ analysis in General Theory of Economics.

Something must now be said about the role of expectations in this connection. Prof. J.R. Hicks in his paper on the ‘General Theory’ singles out this feature for special mention.

The “use of the method of expectations”, said Hicks, “is perhaps the most revolutionary thing about this book”. Keynes fellthat the current economic theory was frequently unrealistic because it assumed too often a “state when there is no changing future to influence the present”.

Hicks pointed out that on account of the use of ‘expectations’ a progressing and fluctuating economy became the subject matter of Keynes’ study. Expectations lie behind have Investment Demand Schedule, Liquidity Preference Schedule and Multiplier. His emphasis on expectations introduces a dynamic element, as the level of employment at any time depends not on the existing state of expectations as existed over a past period, also on the state of expectations yet to come. Thus, General Theory is more than just a comparative statics theory. This has given the impression to many readers that the ‘General Theory’ is a dynamic theory because it runs in terms of expectations.

Mr. Keynes’ treatment of expectations is sometimes regarded as dynamics. Prof. Hicks remarks that “the subject matter for Keynes’ study and analysis is not the norm of a state, but a changing, progressing, fluctuating, economy”. He wrote, “Once, the missing element—anticipations—is added, equilibrium analysis can be used…in the real world in disequilibrium”. He begins by introducing time: “Time usually elapses, however—and sometimes much time—between the incurring of costs by the producer and the purchase of the output by the ultimate consumer”.

The entrepreneur has to form the “best expectations he can so as of what the consumers will be prepared 10 pay when he is ready to supply them”. The modern entrepreneur, since he must produce by “processes which occupy time” has no choice but to be “guided by these expectations” which fall into two groups. One relating to the producer and these may be called “short-term expectations”, and the other may he called “long-term expectations”—these relate to the prospective returns which can be anticipated from a long-term, durable asset. In other words, short-term expectations have to do with the outlook for sales; long-term expectations have to do with investment in fixed capital.

It must, however, be noted that the introduction of expectations does not, by itself, make his theory dynamic. As has been pointed out above that the mere use of expectations as determinants of equilibrium situations is not enough unless we are able to show how these expectations are formed or determined. Prof. Schumpeter criticized Keynes treatment of expectations on the ground that these were not linked to cyclical situations that gave rise to them. This, however, is not so simple as has often been made out.

This argument of ‘once-over’ change explained above applies to this case also. Suppose a change takes place in people’s expectations about prices, the amount demanded will also change. If the change in expectations is continuous and persistent, the amount demanded will also be continuously shifting and we will be facing dynamic conditions. But if the shift in expectations is once and for all, the static demand schedule will again govern the market. Here also we have a case of comparative statics which should always be distinguished from pure dynamics.

It is quite interesting lo comment upon Hicks’ treatment of dynamics in parts III and IV of his classic work. “Value and Capital” in the light of the argument advanced above—we find that it lacks the true spirit of dynamics. Throughout his analysis in the book Hicks seems to be concerned with a ‘onceover’ change in fundamental conditions. Although he shows that the changes in price expectations may result in adjustment often lagged and alien to static equilibrium, yet his primary concern appears to be lo show how a stable equilibrium similar to the old fashioned static equilibrium will be established.

Hicks treatment, therefore, has to be distinguished from pure dynamics. “Now, in a sense, it is true that the explicit introduction of expectations tends to make a theory dynamic. In the sense, namely, that the introduction of expectations into causal nexus is essentially an incomplete idea which requires, in order to become at all useful, a complement which makes the theory dynamic ; if we confine ourselves to saying that it is not actual (current) prices, costs, profits etc. ; but expected prices, costs, profits which induce an entrepreneur to produce and to invest, we do not say very much, unless we give some hint as to how these expectations are determined.”

A theory which takes the expectations as given at any point of time, and does not say anything on how they grow out of past experience, is of very little value, for such a theory would still be static, and it is almost impossible to determine expectations as such. Only if it is possible to give some hypotheses about how expectations are formed on the basis of past experience (prices, state of demand, costs. profits etc.) can a really useful and verifiable theory be evolved. And such a theory is evidently dynamic in the sense explained above, for it links the past with the present, past prices, costs and profits in the state of expectations with the present production, consumption and investment.