Bradley W. Bateman
Two of the stylized facts about modern macroeconomics are that Maynard Keynes invented it in 1936 with the publication of his General Theory of Employment, Interest and Money and that this basic apparatus was supplanted by the rational expectations revolution in the 1970s. While there is just enough substance behind each of these two myths for them to have become widespread, they hide as much as they reveal about the true evolution of ideas that led to modern macroeconomics. In particular, they hide the fact that Keynes was the first theorist to introduce an explicit analytical model of expectations into macroeconomics. Contrary to the canard begun by Paul Samuelson, in his obituary notice of Keynes, that the General Theory “paves the way for a theory of expectation, but it hardly provides one” (1946:320) it is actually the case that Keynes was the product of an intellectual tradition that had paved the way for a theory of expectation, but he ultimately had to provide it himself. 1
The need for a theory of expectations in the explanation of aggregate economic behavior was always implicit in the Cambridge tradition in which Keynes was trained. From the time of the “founding” of the school in 1885, when Alfred Marshall returned to Cambridge to take the chair of Political Economy, Cambridge theorists routinely explained the business cycle as the result of errors of optimism and pessimism on the part of businessmen. This explanation of the cycle actually dated from at least 1837 with Lord Overstone, and was formally adopted by Marshall and his wife, Mary Marshall, in 1879 with the publication of their Economics of Industry. There the Marshalls describe how confidence and “her magic wand” (p. 155) can excite businessmen’s expectations of profit and how these expectations ultimately end in a situation in which businessmen lose their confidence and a “trade storm” ensues. 2 Marshall repeated these arguments verbatim in his Principles (1890) and redeveloped them in Money, Credit and Commerce (1923) which was published shortly before his death.