What Is Expected Price Level?

In Keynesian economics, anticipation occupies an important position. The basic reason is that it emphasizes the decisive influence of future uncertainty on people's economic behavior.

Keynes' theory of expectations

Keynes divides expectations into short-term and long-term, and believes that short-term expectations are price expectations, which determine the current output and employment of manufacturers; while long-term expectations refer to capital flow preferences, investors will hold money or invest in securities Choosing between profitability, this expectation is often unstable. Keynes's anticipation theory is mainly reflected in works such as The Theory of Currency Reform (1923), The Theory of Currency (1930), and the General Theory of Employment, Interest, and Currency (1936, hereinafter referred to as the General Theory).

1. Anticipation theory in Keynes's "Monetary Reform"

In "Currency Reform Theory", Keynes germinated the basic idea of expectations, mainly the explanation of exchange rate expectations, price expectations (inflation expectations) and profit expectations. Regarding exchange rate expectations and related views, he believes that the misunderstanding of the quantity theory of money is to assume that changes in the quantity of money will not affect the number of consumption units that people need to hold in the form of money. This assumption may be true in the long run, "but this long-term misleads the current affairs. We are going to die in the long run." He emphasized the role of expectations in the exchange rate decision, and also emphasized the impact of expectations on currency demand, arguing that expectations of inflation reduced people's confidence in holding money. Regarding price expectations, in a further analysis, Keynes studied the impact of price expectations on production. If people expect prices to fall, there will not be enough adventurers willing to put themselves in a speculative "long position", and business owners will hold back, dare not participate in long production processes, dare not engage in advance currency expenditures and afterwards Recovered long-term advances caused unemployment. Not only that, if some expectations of price trends are quite common, the results will have a cumulative effect. For example, the fact that if the business community anticipates that prices will rise and take corresponding actions, the fact itself will cause a temporary rise in prices. If such expectations are confirmed, it will further strengthen the original expectations; the expected effect of price declines is exactly the opposite. Therefore, a relatively weak cause may cause a large fluctuation. Keynes's theory of price expectation is the main expectation theory in The Theory of Currency Reform.

For profit expectations, Keynes analyzed the impact of the "short" psychology on price levels and profit volumes. He believes that the price level of total output and the amount of total profit are jointly determined by four factors, such as the savings rate, the cost of new investment, people's short-mindedness, and the amount of savings deposits. What is the expected profit? It directly affects the investment decisions of business owners.

It can be seen that in "The Theory of Currency Reform", Keynes has paid attention to the study of anticipation. Although he has not yet formed a systematic theory of anticipation, he has shown that Keynes was genius in the bud of anticipation. It laid the foundation for future Keynesian theoretical research.

2. Anticipation theory in Keynes's "Money"

Keynes's theory of anticipation was originally derived from his earlier work, The Theory of Money. In Monetary Theory, Keynes developed Marshall's equation for the amount of cash balances, dividing cash balances into three types: income deposits, operating deposits, and savings deposits. Income deposits (M1) are prepared by individuals to meet the point-in-time separation of daily income and expenditures. Business deposits (M2) are cash and deposits reserved for business purposes. Savings deposits are for investment opportunities or to earn interest. Dividing the cash balance into three types of deposits and the motive for holding cash into transactional motivation, caution (precautionary) motivation, and speculation in speculation are easy to associate, which provided an initial form for Keynes's future preference theory of liquidity. The theory holds that when people are unpredictable about future changes in the state of affairs, they tend to hold money. This psychological state is an important basis for the existence of liquidity preferences. He believes that long-term expectations are consistent with equilibrium values, while short-term expectations make the economy volatile.

In The Currency Theory, Keynes initially discussed the impact of expectations on the behavior of business owners and thus the level of economic activity. Because production takes time and business owners need to anticipate at the beginning of the production process, the relationship between savings and investment may affect the demand for their products at the end of the production process, Keynes considers this to be noteworthy, and says "obviously expected The new operating profit or loss, not the actual profit or loss that has just been settled, determines the production scale of the business owner and whether it is worth providing so much to the factors of production. Therefore, strictly speaking, it is the expected profit or loss that is the change The main reason is that the banking system can also influence the price level by forming appropriate expectations. "Expected profits or losses have an important impact on business owners' investments. It is the main reason for the level of economic activity, because the attractiveness of investment is determined by the contrast between the expected income that a business owner can expect from the current investment and the interest rate he must pay for production funds. If the expected income is greater than the interest rate that the production funds must pay, then the business owner is willing to invest.

It can be seen that in "Money", Keynes initially discussed the effect of expectations on business owners and thus economic activities. Economic activity throughout society is closely related to expectations. These views are Keynes's preliminary views on anticipatory thoughts, and they are not mature anticipatory theories. If Keynes's discussion of the role of anticipation in "The Theory of Money" is only preliminary, the anticipatory theory in "General Theory" is more in-depth.

3. Anticipation theory in Keynes's General Theory

In The General Theory, Keynes further clearly put forward the expected role and made it the dominant idea of macroeconomic theory. The concept of anticipation occupies an important position in the General Theory and is one of the factors that constitute economic fluctuations. The concept of anticipation as a psychological factor is the cornerstone of Keynes's macroeconomic theoretical system. He believes that expectation is an important factor affecting aggregate supply and demand, and even a decisive factor leading to economic fluctuations. Keynes's analysis and discussion of employment levels, money supply and demand, investment levels, and business cycles are all based on the concept of expectations. In initiating macroeconomic theory, the expectation concept advocated by Keynes was the expectation of manufacturers. He believes that employment levels, money demand, investment levels and trade cycles are all related to expectations. As a result, he established and perfected his anticipatory theory, and contributed to the development of anticipatory theory.

In the book "General Theory", Keynes's analysis of employment levels, examinations of money demand, investment levels, and economic cycles are based on examinations of expected categories. Therefore, some Western economists believe that the significance of Keynes's theory of expectations lies in the importance of uncertainty and expectations in economic analysis. He divided expectations into short-term expectations and long-term expectations, and pointed out their respective status and role. However, it should be noted that although Keynes conducted a pilot study of expectations, it did not actually answer how expectations were formed, that is, did not explore the mechanism by which expectations were formed. Since there is no clear mechanism for expressing the expected formation mechanism, this category of expectations is practically inoperable.

Keynes pointed out in the theory of money demand that people invest in securities based on the motive of speculative profit, that is, they believe that their views on the future are better than the average person in the market, so they want to profit from them. Because people have different expectations of the future trend of market interest rates, there will always be some people holding securities and some people holding currencies. Because holding money must sacrifice the future income of investment securities at the expense of investment in securities at the expense of currency liquidity, there is a problem of opportunity cost for investors in making choices. Anyone who is convinced that the future interest rate is lower than the current interest rate will throw out currency investment securities in the market, with a view to selling them at a higher price when the future securities price rises, and earn speculative profits from it to obtain the expected return. Conversely, anyone who is convinced that the future interest rate is higher than the current interest rate will sell securities in the market and recover the currency in order to avoid possible losses in the future when the price of securities drops. Based on psychological expectations, he proposed that people will make decisions based on their own predictions of other people's choices. The decision of most investors is "can only be regarded as animal blood of immediate action, not the result of weighted probability judgment."

The analysis of expectations and uncertainties is one of Keynes's major contributions in The General Theory, and also an important basis for Keynes to build his theoretical system. In the writings of Keynes in the 1930s, he more explicitly raised the issue of expectations as the dominant idea of his macroeconomic theory, arguing that expectations are important factors affecting aggregate supply and demand, and even cause economic fluctuations. Decisive factor. As a result, great changes have taken place in economic theory. It can be said that Keynes's theory of expectations and production and employment levels is a major dividing line in the history of economic thought. It can be said that the "revolutionary" of the Keynesian system lies in that he abandoned the equilibrium analysis in the classical deterministic environment and emphasized the choice and decision-making under uncertainty. In Keynes's General Theory, the core subject of entrepreneurs is full of expected behaviors of uncertainty. Keynes emphasized that the basis of choice lies in the vagueness of future events and the environment and the expectation that it will change easily. Because this expectation lacks a practically solid foundation, it is vulnerable to the influence and influence of others and the outside world.

In Keynes's theoretical system, the discussion of expectation is hypothetical and scattered, rather than analytical and empirical. Therefore, his category of expectation is not an applicable concept, especially the lack of operability. Moreover, in Keynes's macroeconomic model, the formation of expectations is outside the scope of economics and belongs to the category of psychology. As some scholars (Willis, 1994) said: "Keynes was The book treats expectations as exogenous variables, >> ". His expectations also mainly refer to people's subjective emotions and psychological conditions, and rational economic forecasts based on macroeconomic models; he is still far from rational expectations, so he is called "irrational expectations".

"Confidence" is a factor affecting the demand for money. Keynes's theory of expectations placed particular emphasis on the role of confidence. On the basis of Marshall's view of "confidence" as a key factor in the business cycle, in analyzing unemployment, he believed that the lack of confidence in price stability was the only reason that unemployment could not be saved. In The General Theory, Keynes wanted to figure out "at any time, what determines the national income of a particular economic system, or the amount of employment". According to Keynes, the level of output depends on the consumer spending of the residential sector and the investment expenditure of the manufacturers. Residents' consumption expenditure is endogenous and largely negative, and it depends on income rather than interest rates. The long-term marginal consumption tendency that determines household consumption is basically stable, so national income is mainly determined by investment. Investment expenditure depends on the expected profit margin of the investment and the interest rate representing the cost of borrowed funds. Therefore, employment depends on investment expenditures, which are prone to widespread and sudden fluctuations due to the adequacy of people's "confidence". In The General Theory, Keynes also believes that making investment decisions is difficult, because machines and plants need to be purchased now, and the products produced are sold in an uncertain future. Therefore, the calculation must include demand and cost. Future levels of expectations, hopes, fears, and people's "confidence" all influence investment decisions.

It can be seen that, after the germination of anticipation thoughts in the Theory of Currency Reform, further research in the Theory of Currency, and the full play of the General Theory, Keynes's anticipation theory gradually matured and established his richness. Rational Expectation Theory.

Keynes's theory of expectations directly served his government intervention claims. In Keynes view, expectations have variability. This variability is often driven by animal spirits . Therefore, the expected profit rate is called the marginal efficiency of capital by Keynes. It must be very unstable. Investment decisions may be subject to irrational optimism. Or the impact of pessimism, causing fluctuations in economic operations. We are optimistic about the future and the economy is prosperous; we are pessimistic about the future and the economy is depressed. When the present and the future are linked, the future profit rate of the investment is much more important than the interest rate. Therefore, the investment affected by the future expected profit rate becomes an important fluctuation factor in economic life. This leads to a policy conclusion that is quite different from the classical tradition, that since corporate investment is so unstable, the government must intervene in the market during economic depression. Therefore, Keynes's theory of expectations directly served government intervention.

Keynesian expectations laid the foundation for state intervention. His logic is that the reason why involuntary unemployment exists in the capitalist world is because of insufficient effective demand; the lack of effective demand is the result of three major psychological laws, namely diminishing marginal consumption propensity, declining marginal expected profit rate of capital investment, and liquidity. Impact of preferences; to increase effective demand, this requires state intervention and corresponding macroeconomic policies. Views on long-term expectations have led to important policy conclusions that he believes government intervention in the economy is necessary. Due to the impact of psychological expectations on investment and consumption, as income increases, the marginal investment efficiency and marginal propensity to diminish capital are diminishing. Therefore, it is inevitable that the entire society will be unable to achieve full employment and often lack effective demand. In order to balance the total supply and demand of society, the government should fully intervene in the economy. People's long-term expectations in an uncertain economic environment have a great irrational impulse, which makes investment behavior often controlled by the "animal spirit", so economic fluctuations are inevitable. In this situation, on the one hand, he believes that long-term stable full employment levels are difficult to achieve, which makes it necessary for government intervention in the market; on the other hand, he believes that long-term expectations are often stable and the formation of economic practices It is not completely chaotic and unstable, which in turn makes it possible for government intervention in economic life.

In order to overcome the effects of negative expectations and increase effective demand, he believes that once the government expands effective demand in order to achieve full employment, the market will resume its function. This shows that he does not consider the market to be completely ineffective. With a stable level of full employment, the market mechanism is still the basis of economic operation, but the perception of the irrational impulses that ordinary people have when forming long-term expectations has made him feel that investment fluctuations are inevitable. Cyclical economic fluctuations always come from time to time. Therefore, the government's macro-control of economic operations should be regular. However, since it is difficult for the market mechanism to create and maintain a sufficient level of employment, the limitations of rational calculation in the market system must be overcome by the rational behavior of a wise government. The government should actively increase effective demand and strengthen investment through public investment. Socialization.

Keynes 'overemphasis on the impact of expectations on government policy is a major feature of Keynes' theory of expectations. He advocated that the government should fully intervene in the economy when the effective demand was insufficient. The reason was that the marginal efficiency of capital was diminishing, and this diminishing was brought about by expected factors. Although the functioning of the macroeconomy is inseparable from the role of the government, it cannot rely solely on the government's actions to achieve full employment levels. To achieve the desired purpose, the government must attach importance to the expected role and influence. Keynes exaggerated the role of the government in regulating the economy on this issue, because he ignored the role of rational expectations that would offset the role of the government in implementing macro-control. Sometimes people's rational expectations and their countermeasures even make them completely invalid. In the government's macro-control process of economic operation, people must have correct analysis and prediction of government intervention, and investment behavior must be matched with government investment behaviors for full employment. At this time, people's behavior must be "rational". Without this, government behavior will not be able to achieve a full employment equilibrium under any circumstances, and its goal will suffer setbacks due to investors' "irrational" behavior. It can be said that Keynes's comprehensive government intervention in the economy is closely related to his theory of expectations. It is his anticipatory theory that advocates government's comprehensive intervention in the economy in practice. However, his government's claim for comprehensive intervention has been attacked by modern monetarist and rational anticipation schools. This makes people doubt the application value of Keynes's expectation theory.

1. Vague definition of the expected subject

When it comes to expectations, in addition to what is expected and how it is expected, there is who is expecting, that is, who is expected to be the subject, whether it is the government, business, or residents. Otherwise, it is difficult to judge whether the expectation is consistent with the actual situation. Therefore, the subject of the expectation is the person who performed the expectation. Keynes's analysis of long-term expected states mainly involves the investment behavior of "entrepreneurs", but this entrepreneur is sometimes the owner and manager of the enterprise, and sometimes it becomes an investor in the stock market. problem. On the one hand, is the long-term expectation of an enterprise made by a single entrepreneur, and can it be reduced to a personal expectation? On the other hand, in the process of forming expectations between the entrepreneur as an enterprise and the entrepreneur as an investor, are the two unified or separated? Regarding the former, although Keynes had some understanding of the growth of large corporations and the end of laissez-faire, he clearly did not realize the seriousness of the problem. He believes that the formation of long-term expectations of enterprises is the behavior of a single person. However, as an organization, the anticipation process is far more complicated than that of a single person. Conflicts of interest and institutional structure within the organization restrict the expected behavior of organizational members. The formation of long-term expectations of the company is formed by the game of many people in the existing institutional structure. it's wrong. For the latter, Keynes avoided the imagination that investors in money and capital would compare between two types of expected returns, that is, the expected return on investment converted into a means of production and the expected future interest rate obtained by lending funds to financial institutions. In fact, his discussion of long-term expectations is mainly focused on the stock market, not the accumulation of means of production. It can be seen that the expected subject in Keynes's expectation theory is very vague. It is its ambiguity that has caused a major flaw in Keynes's irrational expectations.

2. Neglect of the role of rational expectations

Although Keynes attaches great importance to the role of expectations, the expectations he emphasizes are adaptive expectations, not rational expectations. Because of the neglect of the role of rational expectations, it is difficult for certain economic policies to play the expected role. Therefore, Keynes's theory of expectations is not a scientific theory of expectations. It is a justification for the exploitation of capitalist investment. For the school of rational anticipation, anticipation is endogenous to the model and can be explained by economic theory, so anticipation can be determined. The rational expectation school believes that Keynes believes that discretionary fiscal and monetary policies can actively interfere with the total output and employment determined by the natural rate level, which is wrong. Only new Keynesian economists who absorbed rational expectations believe that rational expectations are a rich description of how to form the rationality of expectations. Long-term labor contracts often prevent the complete adjustment of wages and prices, enabling them to Price levels change, so wages and prices are somewhat inelastic, which overcomes the deficiencies of Keynesian expectation theory. Keynes's expectations were, after all, irrational expectations.

3. Exaggeration of psychological expectations

Keynes's expectation theory is the theory of psychological expectation, which regards psychological expectation as the only factor that determines people's behavior. In explaining the formation of expectations, he overemphasized the role of "psychological" factors and ignored objective factors such as institutional structure, habits, and traditions, thereby making expectations an exogenous variable of the economic system. In Keynes' theory of psychological anticipation, anticipation becomes a spontaneous influence introduced from the outside, rather than an inherent element formed in the analysis process. Investors use long-term expectations as the basis for their investment, but this long-term expectation is like the first driving force in Newton's world, and it is quite mysterious-you ca nt understand its formation mechanism, and how and how How did you get into people's heads? "It basically attributed expectations to people's psychological factors, but did not really explore the formation of expectations from the field of economics or the application of economic analysis methods." Keynes explained with various psychological expectations, bringing people into the theoretical maze of human religion. In Keynes's macroeconomic model, the formation of expectations is placed in the field of psychology and not in the field of economics, so it does not belong to strict economic analysis. In the process of expectation formation, psychological factors should not be excluded from any complete theoretical explanation, but it is also wrong to ignore the influence of institutional structure, habits, and traditional factors on this process, and to completely use psychological reasons to explain expectations.

4. Contradictions about long-term expectations

Keynes's long-term expectations are both unstable and stable, and therefore contradictory. "The long-term expectation, that is, the basis on which we make decisions, depends not only on which prediction has the highest probability, but also on how confident we are in making that prediction." Confidence affects and is therefore unstable, and he has also analyzed this long-term expected instability in conjunction with the stock exchange. However, he added: "The long-term expected state is stable, and when it is unstable, there are other factors that exert its stabilizing effect." However, he has not analyzed this stabilizing effect. Therefore, Keynes's long-term expectations are both unstable and stable, and they are contradictory.

Although Keynes told everyone not to forget the irrationality in his head, he himself fell into the rationalist superstition. In Keynes's theory of expectation, he pointed out the irrational impulses in long-term expectation and mentioned the "animal spirit" of people; on the other hand, his policy conclusions must rely on the support of people's rational behavior. Keynes only insisted on the rationalist idea of behavior, not a rationalist in the philosophical sense. Despite all the impulse, the behavior of economic parties accepts as much intellectual and computational control as possible. He is unique in that the uncertainty of the future makes rational calculations meaningless and infeasible in many cases, but his thinking and inferential ability are still highly valued, and it is for this reason that he is wise to the wise. Persuasion is full of confidence.

Keynes emphasized the uncertainty of the future and at the same time the role of expectations. He "brought expectations and uncertainty to the core of economic theory research, which is a great contribution to the development of economic theory."

Keynes's introduction of expectations into the theory is indeed a major development in economics, and the resulting policy consequences are even more controversial issues in economics. Keynes's theoretical analysis of long-term expectations has generated a lot of controversy and broadened the horizon of economic research. "After Keynes, the theory of expectations continues to be valued by economists, and expectations are also studied as endogenous variables of the economic system."

Keynes's theory of "irrational expectations" was criticized by modern monetaryist Milton Friedman. Friedman believes that Keynes s expectation theory applies adaptive expectations in the establishment of macroeconomic models. It assumes that people expect the future based on past values, which is reliable when there is a certain relationship between economic variables. However, the relationship between variables is not static. In Friedman's view, before making economic decisions, people always need to make predictions about the future prospects of economic activities, but because people cannot fully or fully understand all information, they can only use their own past knowledge or experience to Form expectations, so they usually can only gradually modify their expectations based on changes in economic activity and adjust their behaviors to adapt to changes in economic aggregates such as prices. In this way, the effectiveness of Keynesian policies to reduce unemployment by inflation becomes a problem. Specifically, in the short term, if the government implements an inflation policy and people make currency wages slower than price increases due to wrong expectations, then when employers feel real wages fall, they will hire more workers, and workers will not have time to adjust Price expectations, and therefore believe that the increased monetary wages represent higher real wages, and are therefore willing to work. As a result, inflation has stimulated employment growth. However, this situation will not last. In the long run, once workers learn that money wages cannot buy as many items as expected, and realize that real wages have fallen, they will have adaptive expectations and demand to increase accordingly. Wages may be reduced to accommodate rising prices. It can be seen that inflation policy can work in the short term, but not in the long run.

Keynesian economists such as Robert Lucas Jr., and others, explored the mechanism of expectation formation not from psychology but from the field of economics. But then came the opposite of Keynesian economics. In Western economics, there are many skeptics of Keynesian expectation theory, but it is clearly pointed out that the flaw of Keynesian economics is the school of rational expectations. The formation of rational expectations theory has become the theoretical basis for negating Keynes's theory and policy claims. Of course, no matter how rational a rational expectation is, it can never change the fact of future uncertainty. Uncertainty in the future will always make various expectations, including rational expectations, not fully in line with the actual operating conditions of the economy, or in other words, it will always cause expectations to have incomplete rational characteristics.

Keynes believed that it is expected that the economy will change from one equilibrium position to another. The expected change is the main cause of cyclical fluctuations, which will help the government to play an expected positive role in overcoming the negative effects of macroeconomic regulation and economic cycle. Impact provides a reference.