Sudden and Violent Changes in Long-Term Expectations: Keynes and Reality

Forthcoming in "Taking up the Challenge!", 2015, Festschrift for Jürgen Backhaus, Helge Peukert (Ed.), Weimar bei Marburg, Metropolis

18 Pages Posted: 10 Apr 2015 Last revised: 1 Jul 2015

Date Written: May 8, 2015

Abstract

This study takes up Keynes’ ideas concerning long-term expectations, particularly his notion that expectations are subject to sudden changes with strong effects on economic activity. We start by detailing Keynes’ views regarding the nature of expectations and their role in the business cycle. I first argue that it is wrong to judge long-term expectations as being unstable and unpredictable based on the experience of the variability of stock prices. The link between the expectations that underlie investment decisions and stock prices is too weak. Hence, in order to check Keynes intuition I suggest assessing survey data on expectations and newer contributions from the side of behavioral economics. Whereas survey data do not offer much support for Keynes, the recently introduced concept of pattern-based expectations does. These expectations are built up from data elicited in the laboratory and describe how people actually form forecasts and how they assess uncertainty. I show that before and during the great recession of recent years expectations were very likely to be a driver of the cycle.

Keywords: Long-term expectations, Keynes, business cycle

JEL Classification: B22, D84, E12

Suggested Citation

Rötheli, Tobias F., Sudden and Violent Changes in Long-Term Expectations: Keynes and Reality (May 8, 2015). Forthcoming in "Taking up the Challenge!", 2015, Festschrift for Jürgen Backhaus, Helge Peukert (Ed.), Weimar bei Marburg, Metropolis , Available at SSRN: https://ssrn.com/abstract=2591812 or http://dx.doi.org/10.2139/ssrn.2591812

Tobias F. Rötheli (Contact Author)

University of Erfurt ( email )

Postfach 900 221
Nordhauserstrasse 63
D-99105 Erfurt
Germany
+49 361 737 4531 (Phone)
+49 361 737 4539 (Fax)

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