The State Of Long-Term Expectation
We have seen in the previous chapter that the scale of
investment depends on the relation between the rate of interest and
the schedule of the marginal efficiency of capital corresponding to
different scales of current investment, whilst the marginal
efficiency of capital depends on the relation between the supply
price of a capital-asset and its prospective yield. In this chapter
we shall consider in more detail some of the factors which
determine the prospective yield of an asset.
The considerations upon which expectations of prospective yields
are based are partly existing facts which we can assume to be known
more or less for certain, and partly future events which can only
be forecasted with more or less confidence. Amongst the first may
be mentioned the existing stock of various types of capital-assets
and of capital-assets in general and the strength of the existing
consumers' demand for goods which require for their efficient
production a relatively larger assistance from capital. Amongst the
latter are future changes in the type and quantity of the stock of
capital-assets and in the tastes of the consumer, the strength of
effective demand from time to time during the life of the
investment under consideration, and the changes in the wage-unit in
terms of money which may occur during its life. We may sum up the
state of psychological expectation which covers the latter as being
the state of long-term expectation - as distinguished
from the short-term expectation upon the basis of which a producer
estimates what he will get for a product when it is finished if he
decides to begin producing it to-day with the existing plant, which
we examined in chapter 5.
It would be foolish, in forming our expectations, to attach
great weight to matters which are very uncertain. It is reasonable,
therefore, to be guided to a considerable degree by the facts about
which we feel somewhat confident, even though they may be less
decisively relevant to the issue than other facts about which our
knowledge is vague and scanty. For this reason the facts of the
existing situation enter, in a sense disproportionately, into the
formation of our long-term expectations; our usual practice being
to take the existing situation and to project it into the future,
modified only to the extent that we have more or less definite
reasons for expecting a change.
The state of long-term expectation, upon which our decisions are
based, does not solely depend, therefore, on the most probable
forecast we can make. It also depends on the confidence
with which we make this forecast-on how highly we rate the
likelihood of our best forecast turning out quite wrong. If we
expect large changes but are very uncertain as to what precise form
these changes will take, then our confidence will be weak.
The state of confidence, as they term it, is a matter
to which practical men always pay the closest and most anxious
attention. But economists have not analysed it carefully and have
been content, as a rule, to discuss it in general terms. In
particular it has not been made clear that its relevance to
economic problems comes in through its important influence on the
schedule of the marginal efficiency of capital. There are not two
separate factors affecting the rate of investment, namely, the
schedule of the marginal efficiency of capital and the state of
confidence. The state of confidence is relevant because it is one
of the major factors determining the former, which is the same
thing as the investment demand-schedule.
There is, however, not much to be said about the state of
confidence a priori. Our conclusions must mainly depend
upon the actual observation of markets and business psychology.
This is the reason why the ensuing digression is on a different
level of abstraction from most of this book.
For convenience of exposition we shall assume in the following discussion of the state of confidence that there are no changes in the rate of interest; and we shall write, throughout the following sections, as if changes in the values of investments were solely due to changes in the expectation of their prospective yields and not at all to changes in the rate of interest at which these prospective yields are capitalised. The effect of changes in the rate of interest is, however, easily superimposed on the effect of changes in the state of confidence.