Notes
1 The ideas in this chapter are discussed at length in Crotty (1994).
2 This assertion is defended in Appendix 1.
3 I am not sure why the central role in the determination of the mec played by agents' confidence in their expectations disappeared from Modern Keynesian investment theory.
One likely reason for this is that the concept that agents have variable subjective confidence in the truth content of their expectations is incompatible with the use of both objective and subjective probability distributions as representations of agent expectations in New Classical and neoclassical theories of rational agent choice, respectively.However, Keynes may have contributed to this development himself with his formal definition of the mec in chapter 11. The mec is defined there as that value of m for which the following equation holds: EQtE/(1 + m)t = Ps1, where t is a time index from 1 to T, T is the expected life of the investment good, QtE is the net cash flow expected to be generated by this investment in future period t, and Ps1 is the cost of the investment good in period t. The mec is clearly a profit rate of sorts - an internal rate of return - since it will be higher the larger the expected profit flows, the more the total expected profit flows are front-loaded, and the lower the cost of the investment good. Keynes also said, "I define the marginal
Chapter 12 of The General Theory 263 efficiency of capital as being equal to that rate of discount which would make the present value of the series of annuities given by the returns expected from the capital-asset during its life just equal to its supply price" (CW 7, p. 135, emphasis added).
This definition creates a serious problem in Keynes's theory because annuities are payments due the owner whose value is specified in a contract; there is no uncertainty about their nominal value.
Thus, contrary to Keynes's claim in chapter 12 that the mec is a function of both expected profit flows and confidence in those expectations, the mec formula does not incorporate the effect of confidence on the capital investment decision at all. Under this definition of the mec, fundamental uncertainty has no influence on the level or the volatility of capital investment spending. Minsky commented that "the introduction of uncertainty... was never formalized to the same extent as the other functional relations" (Minsky 1975, p. 60). To remain consistent with everything in The General Theory but the formal definition of the mec in chapter 11, we will assume that the degree of confidence that agents have in the truth content of their expectations of the future is a crucial determinant of their decisions.4 The problems caused by excessive liquidity are explored in Appendix 2.
5 In a footnote, Keynes tells us that "when a company's shares are quoted very high so that it can raise more capital by issuing more shares on favourable terms, this has the same effect as if it could borrow at a low rate of interest. I should now describe this by saying that a high quotation for existing equities involves an increase in the marginal efficiency of the corresponding type of capital and therefore has the same effect (since investment depends on a comparison between the marginal efficiency of capital and the rate of interest) as a fall in the rate of interest" (CW 7, p. 151). This seems to me to be an unhelpful and confusing conflation of two quite different variables.
6 There is a large and contentious literature about the empirical validity of Tobin's q theory of investment.
7 Keynes put a footnote here that stressed that by " ‘very uncertain' I do not mean the same thing as ‘very improbable'" (CW 7, p. 148). He is theorizing radical uncertainty, not probabilistic risk.
8 The words "no strong roots to hold it steady" mean that confidence in the truth content of expectations has evaporated.
9 The argument in the last few paragraphs is presented in greater detail in Crotty (1994).
18