ABSTRACT
After having criticized the microfoundations literature for not providing macroeconomics with individualistic foundations, it is time to see in what way we can bring this literature closer to the tenets of MI. 1 It will be clear that once the requirements of (Nash) equilibrium or rational expectations are relaxed many outcomes are possible. The view that MI itself does not impose severe restrictions on the possible state of affairs at the aggregate level is very close to one of the possible readings of Keynes' General Theory. In Keynes' view, investment, and hence equilibrium output, largely depends on entrepreneurial expectations. According to Keynes, hardly any restriction can be imposed on these expectations, so that almost any level of output can be justified as an equilibrium level. Two arguments are used to sustain this view. The first is that there is no scientific basis to make (probabilistic) predictions about the magnitude of economic variables in the distant future: long-run expectations are determined by ‘animal spirits’. It is this fundamental uncertainty that the economic theories considered in this study have problems dealing with. 2 The second argument is that economic agents might realize that the (future) state of the economy depends on the behaviour of all (other) agents. In forming expectations about this (future) state, they will realize that other agents' behaviour also depends on their expectations. (This is the problem of endogenous uncertainty, referred to in chapter 2.) Thus, an iterative process of expectations of other agents' expectations is set in motion. Both arguments can be found in Keynes (1936), but the second one is more pertinent to the present study. In a discussion of the famous beauty contest Keynes argues
It is not the case of choosing those which, to the best of one's judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees.
(Keynes 1936: 156)