I Am Officially in the Twilight Zone: Callahan and Glasner on Sraffa-Hayek
[UPDATE: I’m slightly editing the “exchange” (which are my words of course) between Hayek and Sraffa to make it closer to their actual words…]
It’s a weird situation, I grant you, but I’ve been running around for years saying that the Austrians have never given a good response to Sraffa’s critique of Hayek. (I summarize my views in one of the sections in this paper.)
It’s not surprising that the Austrians haven’t thought much of my view. But what is freaky is that Gene Callahan and David Glasner think I’m wrong too.
But wait, it gets better (worse). Here is my summary of the Hayek/Sraffa debate (on this point of “own rates of interest,” I’m not talking about their broader disagreements), with the vocabulary updated to our terminology:
HAYEK:
To avoid causing an unsustainable boom, the monetary authorities should set the money rate of interest equal to the natural rate.The unsustainable boom occurs when the banks charge a money rate of interest lower than the natural rate.SRAFFA: What the heck are you talking about? Outside of the steady state–but even in an intertemporal equilibrium, where there are no arbitrage opportunities–there are as many “natural rates” of interest as there are goods.
HAYEK: I know that, I’m not stupid.
SRAFFA: So…when you say the
centralbanks should set the money rate to the natural rate, I guessit hasthey have to set the nominal rate of interest equal to different numbers, simultaneously?HAYEK: OK, well, what I’m trying to say is…
Now in fairness to Hayek, he really did get the problem, and he gave a hint of an answer. But that was it. I claim that no one since has ever followed through, certainly not Lachmann who didn’t see the problem. (I tried to sketch what a more comprehensive answer would look like, in my paper that I linked in the beginning of this post.)
OK so assume for the sake of argument that I’ve correctly summarized Sraffa’s criticism. Look at how Glasner and his co-author think they’ve exonerated Hayek:
However, as Ludwig Lachmann later pointed out, Keynes’s treatment of own rates in Chapter 17 of the General Theory undercuts Sraffa’s criticism. Own rates, in any intertemporal equilibrium, cannot deviate from each other by more than expected price appreciation or depreciation plus the cost of storage and the service flow provided by the commodity, so that the net anticipated yield from holding assets are all are equal in intertemporal equilibrium. Thus, the natural rate of interest, on Keynes’s analysis in the General Theory, is well-defined, at least up to a scalar multiple reflecting the choice of numeraire. However, Keynes’s revision of Sraffa’s own-rate analysis provides only a partial rehabilitation of Hayek’s natural rate. Since there is no unique price level in a barter system, a unique money natural rate of interest cannot be specified. Hayek implicitly was reasoning in terms of a constant nominal value of GDP, but barter relationships cannot identify any path for nominal GDP, let alone a constant one, as uniquely compatible with intertemporal equilibrium.
The way I am reading that, it is saying, “Sraffa was wrong to think Hayek had given no guide on how the central bank should set the nominal rate of interest. We can indeed define it, up to a scalar multiple. Really, the problem here is that Hayek didn’t realize there was no unique natural rate of interest outside of the steady state.”
!!!
In other words, they conclude what–I claim–was Sraffa’s original point.
My theory is that it is so mentally taxing for people to work through the relative price change / storage cost stuff, that the 8 people* who have done so since the 1940s think that no one else must have been able to.
* The 8 people being Sraffa, Hayek, Keynes, Lachmann, Gene, Glasner, Glasner’s co-author, and me.
Dr. Murphy,
How does Mises stack up against Sraffa? I mean, according to you you are referring to a specific critique Sraffa made of Hayek, but surely Mises has written about the same subject and I was wondering how Mises stacks up against Sraffa. It is not as odd a question as it might sound. I remember years ago that Garrison commented on Hayek’s business cycle theory having a problem handling a certain criticism, but that Mises’ version of it had no such problem. If I can find the Garrison reference I will post about it later, but I don’t know whether or not I can find it…Thank you
Dr. Murphy,
How does Mises stack up against Sraffa? I mean, according to you you are referring to a specific critique Sraffa made of Hayek, but surely Mises has written about the same subject and I was wondering how Mises stacks up against Sraffa. It is not as odd a question as it might sound. I remember years ago that Garrison commented on Hayek’s business cycle theory having a problem handling a certain criticism, but that Mises’ version of it had no such problem. If I can find the Garrison reference I will post about it later, but I don’t know whether or not I can find it…Thank you
Senyor
(1) All of Mises’s early versions of the ABCT also simply use Wicksell’s natural rate.
E.g., in 1928 in Monetary Stabilization and Cyclical Policy:
“In conformity with Wicksell’s terminology, we shall use ‘natural interest rate’ to describe that interest rate which would be established by supply and demand if real goods were loaned in natura [directly, as in barter] without the intermediary of money. ‘Money rate of interest’ will be used for that interest rate asked on loans made in money or money substitute.” (Mises 2006 [1978]: 107–108).
“The ‘natural interest rate’ is established at that height which tends toward equilibrium on the market. The tendency is toward a condition where no capital goods are idle, no opportunities for starting profitable enterprises remain unexploited and the only projects not undertaken are those which no longer yield a profit at the prevailing ‘natural interest rate’” (Mises 2006 [1978]: 109).
Monetary Stabilization and Cyclical Policy (1928) in Mises 2006 [1978], The Causes of the Economic Crisis and Other Essays Before and After the Great Depression (Ludwig von Mises Institute, Auburn, Ala.), p. 99ff.
(2) by the time of Human Action, Mises switches to an equilibrium rate of interest and the market rate (both monetary rates): Hülsmann, J. G. 2007. Mises: The Last Knight of Liberalism, Ludwig von Mises Institute, Auburn, Ala 253, n. 79.
If the only way a centralized money printer can avoid setting off an unsustainable boom is by setting “the” nominal rate equal to “the” natural rate, and there is not one but multiple natural rates, then Hayek’s actual point is strengthened, because instead of making “a” mistake with one natural interest rate, the centralized money printer would be faced with making MANY mistakes with MANY interest rates.
Contrary to throwing Hayekian/Misesian ABCT under the bus, Sraffa’s “criticism” actually succeeds in strengthening it. For it is far more likely that the Fed would bring about mistakes with many interest rates as opposed to just one interest rate.
Thanks Sraffa! And thank you LK for bringing this up. Your data collection is helping everyone realize that that likelihood of central banks bringing about unsustainable booms is far, far greater than even Hayek and the earlier Mises had originally thought!
“If the only way a centralized money printer can avoid setting off an unsustainable boom is by setting “the” nominal rate equal to “the” natural rate, and there is not one but multiple natural rates, then Hayek’s actual point is strengthened,”
No, it isn’t, because that mechanism for Hayek also explains why ABCs happen even in the absence of a central bank (say, under a free banking system).
But the absence of a single natural rate means that this cannot be the cause of ABCs at all: the entire theory (in these versions using the natural rate) is built on a house of sand, and is unsound.
LK,
In case you missed it, ABCT explains how interest rate depression through credit expansion and commensurate monetary inflation to inject credit beyond the available pool of savings into the production structure causes the unsustainable boom.
So, it is a money economy, you see, not a barter economy. Multiple rates of interest have no place there as we are talking of an existing money commodity unless you are talking of money as just a veil. Arbitrage takes care to ensure that the money rate of interest converges into one number in the long run at equilibrium.
Hence, your claim that this cannot be the cause of the business cycle is rather hollow.
“…also…”
Glad you agree yet again that Hayek’s argument is actually strengthened by Sraffa’s “criticism”.
“But the absence of a single natural rate means that this cannot be the cause of ABCs at all”
No, it means that it cannot be the cause of “an” ABC brought about by the Fed setting “an” interest rate different from “the” natural rate.
It doesn’t mean the Fed setting multiple rates different from their natural rates can’t cause ABCs. Just because Hayek and the earlier Mises didn’t consider them, it doesn’t mean they weren’t there.
We just have to add an “s” to every instance of the phrases “originary interest rate” and “natural rate”.
ABC going plural doesn’t refute ABC.
M_F
Your analysis is correct. If the question at hand is the quantity of existing rates of interest (one or more than one), and Sraffa’s criticism of Hayek is that it’s actually more than one not just one as Sraffa interprets Hayek to mean, then I would love to concede that Sraffa is correct! The Fed, by setting a single “conceited” interest rate is messing with some sectors more than others because while the interest rate may be “correct” for some sectors, it’s wreaking havoc in others with a rate that is either to high or to low for the sector. It’s hard to imagine it being to high though as it’s all smooshed into the floorboards right now.
That quote indicates that he’s using Wicksell’s terminology only, not, and especially not “simply”, his rate.
Hi senyoreconomist
I myself have written about what Mises could have responded to Sraffa. It’s a looong blog-post, but it compensates its longitude with all evidence I find to support my case about:
1) Mises’ interest theory was different and (much) better than Wicksells’
2) Mises’ interest theory was NOT based on a barter rate of interest
3) ABCT in Mises’ writings is NOT based on a “unique” rate, actually the contrary is true
4) ABCT is NOT based on a policy to make money “neutral”, actually it is based on a NON-neutral money
5) The most important of all: ABCT does NOT, I repeat NOT, require that bank’s money rate MUST coincide with a unique “natural” rate. It does NOT require that, all that ABCT says is that banks should NOT expand credit. There can be as many rates as you want, but as long as banks do NOT expand fiduciary media there will not be a boom-bust cycle
Conclusion: Misesian ABCT is totally IMMUNE to Sraffa’ critique.
Here is the link
http://econo-miaytuya.blogspot.com.ar/2013/01/sraffallacies-misesian-defense-of-abct-i.html
Yes, exactly. Interest rates are based on individuals’ time preferences, so there are many interest rates.
Equilibrium, in the Austrian sense, means that the rates are reflective of all individuals’ time preferences; and that those rates will change with the preferences of individuals.
Where the violations of individuals’ rights modify time preferences, the interest rates which are based on such preferences will not be in equilibrium.
What is the “natural rate of interest”? I somehow understand it as what the rate of interest would be at equilibrium. I see it as the rate of interest in a money economy. I fail to see how that leads to barter and own rates of interest on various commodities. I have read your thesis and still do not get how one becomes the other.
As noted below, all this consists of is redefining what Hayek meant by the “natural rate”.
Hayek’s natural rate is not a monetary rate.
Hayek:
“Put concisely, Wicksell’s theory is as follows: If it were not for monetary disturbances, the rate of interest would be determined so as to equalize the demand for and the supply of savings. This equilibrium rate, as I prefer to call it, he christens the natural rate of interest. In a money economy, the actual or money rate of interest (“Geldzins”) may differ from the equilibrium or natural rate, because the demand for and the supply of capital do not meet in their natural form but in the form of money, the quantity of which available for capital purposes may be arbitrarily changed by the banks.
Now, so long as the money rate of interest coincides with the equilibrium rate, the rate of interest remains “neutral” in its effects on the prices of goods, tending neither to raise nor to lower them. When the banks, however, lower the money rate of interest below the equilibrium rate, which they can do by lending more than has been entrusted to them, i.e., by adding to the circulation, this must tend to raise prices; …” (Hayek, F. A. von, 2008. Prices and Production and Other Works: F. A. Hayek on Money, the Business Cycle, and the Gold Standard, Ludwig von Mises Institute, Auburn, Ala. p. 215).
“Put concisely, Wicksell’s theory is as follows: If it were not for monetary disturbances, the rate of interest would be determined so as to equalize the demand for and the supply of savings. This equilibrium rate, as I prefer to call it, he christens the natural rate of interest. In a money economy, the actual or money rate of interest (“Geldzins”) may differ from the equilibrium or natural rate, because the demand for and the supply of capital do not meet in their natural form but in the form of money, the quantity of which available for capital purposes may be arbitrarily changed by the banks.”
Equalizing the demand for and supply of savings is obviously the important thing here.
People don’t need to worry themselves with whether or not the natural rate is singular or plural, in order for the demand for and supply of savings to tend towards equality in a free unhampered market.
lol.. “a free unhampered market” would then require a moneyless economy.
Incidentally, the ERE at equilibrium does not have a place for money. Have doubts? Ask Bob. He’s the guy who teaches that.
“lol.. “a free unhampered market” would then require a moneyless economy.”
False. The demand and supply of savings tends towards equality in a free unhampered market. It does not require abolition or absence of money.
Further, I think you are misinterpreting Hayek even as per the exchange as you have illustrated it. It looks like Hayek is saying the following.
Explicit
1. The Central Bank needs to set it at the natural rate of interest
2. Failing that it will set off an unsustainable boom.
Implicit
3. The Central Bank cannot know the natural rate of interest
4. Hence its act of setting interest rates has an extremely slim chance of not setting off an unsustainable boom.
To Sraffa’s reply, the answer clearly is “If the Central Bank cannot know one natural rate of interest, how can it know many? So the chance that it sets off an unsustainable boom by its action of setting interest rates is extremely high”
I therefore see the entire break-off into multiple own rates of interest as completely futile and irrelevant to Hayek’s main point.
Hmmm, I don’t think there’s any guarantee that setting the wrong rate will set of an unsustainable boom. Suppose they set the rate way too high? That’s the think about an unknown, you can’t tell the difference between “too high” and “too low”.
It would be superfluous and the market would find a rate of interest below that.
Hmmm, well what you are saying is:
[1] The Central Bank does not know the “natural rate”
[2] If the Central Bank sets their rate too low, they lend money out at that rate and there is an unsustainable boom.
[3] If the Central Bank sets their rate too high, they don’t lend any money out and there is no boom.
I don’t think you can hold all three positions simultaneously. The Central Bank can just start with a high rate, and gradually lower it until they lend out some money to someone, then they know they should not go any lower. On this basis all you are saying is that the Central Bank can easily discover the “natural rate” and thus [1] is false on the face of it, but beyond that, the Central Bank should not exist at all because any time they do lend money, there’s a problem.
In other words, you just don’t like the idea of a Central Bank at all… that’s Rothbard’s position.
When I said the market would find a rate of interest below that, I meant outside of the Central Bank. That’s not the same as the Central Bank gradually lowering its rates.
In other words, the Central Bank would render itself superfluous by (unknowingly, of course) setting a rate of interest above the natural rate.
OK, let me put this another way.
Do you believe that any possible circumstance exists where a Central Bank can usefully lend money (at whatever rate) to the economy?
You should be telling me that. There are only 2 mutually exclusive and collectively exhaustive ways of not setting exactly the natural rate of interest
1. Above – Central Bank becomes superfluous
2. Below – Central Bank sets off unsustainable boom
What else do YOU think is possible?
It would depend on whether the free market is the source of the “Central Bank’s” 100% market share.
A free market “Central Bank” would never exist, but I think it’s important to acknowledge the theoretical possibility.
You are demonstrating that you don’t believe a Central Bank can contribute productively towards an economy at all (at least, not in any practical way under the present day scheme). At the best of times it is superfluous, and at the worst of times it causes malinvestment.
So once you have come to the conclusion that the best thing you can do with a Central Bank is get rid of it, there’s no more point in discussing attempts to target any natural interest rate — whether singular, plural or otherwise. That’s Rothbard’s position, and it is a perfectly self-consistent position, but doesn’t match Hayek here.
Personally, I don’t quite see Central Banks as evil incarnate like Rothbard did, but I think there’s a value in providing a lender of last resort at higher than market interest rates, as a way to salvage liquidity problems that can be long-term profitable… the problem is, some of them will NOT be long term profitable, so the Central Bank must by implication also be willing to get somewhat involved in cleaning up bankruptcies. That’s a bit of a side track for the topic at hand.
Bala nails it.
Bravo.
If the CB wants to increase the rate that banks lend money it only has to sell assets in exchange for money.
If it it did this sufficiently it could certainly raise rates above the “natural” level.
No:
(1) The natural rate of interest would be the rate on loans of a physical commodity or commodities used as capital goods.
(2) The significant thing is that the “natural rate” is an “equilibrium rate” for Hayek: it is the rate that clears the various loan markets for real goods lent out as capital goods. These capital loan markets in natura – the loanable funds markets in real capital goods lent out without money – will have market clearing with a natural rate.
(3) Therefore real savings and investment are equated: no intertemporal discoordination (or future lack capital goods in relation to current plans) will result.
(4) But in a world of heterogeneous capital goods which is out of general equilibrium, there could be as many natural rates on each commodity considered as a capital good as there as such commodities.
(5) no monetary system where capital goods investments are made by means of money can hit the right equilibrium natural interest rate on each in natura loan of various capital goods, because there is no such thing.
(6) no monetary system where capital goods investments are made by means of money can hit the right multiple natural interest rates either on each in natura loan of various capital goods, because the banks rates even in a free banking system converge in a spread, yet there could be vast differences between many individual commodity natural rates.
According to the logic of Hayek’s theory, it follows that there is therefore no way in principle for a monetary system of lending for capital goods purposes to achieve intertemporal coordination.
The only way is: to abolish money and return to a barter system.
And even then the whole theory is dependent on unrealistic assumptions about real world tendencies to general equilibrium. There is no reason to think that there are equilibrium interest rates that will clear all loan markets just waiting to be discovered by entrepreneurial activity in a barter world.
http://socialdemocracy21stcentury.blogspot.com/2013/02/the-natural-rate-of-interest-in-abct.html
In the Austrian worldview the number of interest rates are limited by the number of people rather than the number of commodities.
One person has a certain time preference for Commodity A, while another has a different time preference for Commodity A; In this example there are two rates of interest.
“In the Austrian worldview the number of interest rates are limited by the number of people rather than the number of commodities”
Not relevant for Hayek’s definition, or Hayek-Sraffa debate.
There goes LK as I said. The post is up and he has regurgitated it out here. Now, I would be grateful to anyone who can explain how this addresses the logical point I have raised.
LK,
Just answer this. You say
“there could be as many natural rates on each commodity considered as a capital good as there as such commodities.”
Are you saying that there could be different money rates of interest in lines producing different commodities? In simpler terms, are you saying that money capital going into line X can give a money return (we silly Austrians like to call it price spread) of 5% p.a. and, simultaneously, money capital going into line Y can give a money return (price spread) of 10%? If so could you please explain why arbitrage will not drive money capital out of Line X and into Line Y? And if so, could you please explain why price spreads (and therefore money rate of return) in the 2 lines will not become equal?
Once you explain this, things will, I am sure, become much clearer.
Bala, as I showed in my quotes from Hayek, he *agreed* that there could be different “natural rates” on various commodities. In other words, he wasn’t making the move that Lachmann, you, or Gene make in response to Sraffa.
I answered just above. I guess you deleted your earlier comment, but I had already submitted my response taking extracts from that comment.
By deleting your comment, you’ve screwed up the comment thread 🙂
Bob,
Please can you spell it out more clearly as I am not getting what you are saying at all.
Straffa said that Hayek’s theory didn’t make sense because in barter (that Hayek’s model was supposed to mimic) there would be multiple own-rates of interest (one for each commodity in which loans were made). Therefore there was no single natural rate for the economy that it could be said to be below for ABCT to be seen.
Lachmann showed that this didn’t matter. Even in barter economy the multiple own -rates would be aligned in equilibrium and in addition there would be tendency in the economy to seek out these equilibrium.
This seems to disprove Straffs’ claim.
What am I missing ?
(I can see that in a barter economy that happened to be out of equilibrium that it may be hard to see how ABCT plays out as at any given moment some own-rates would be above and some below there natural rates. But that seems irrelevant to me. Lachman established that in theory they could be aligned and in a monetary economy there is only money rates to be considered – and monetary theory shows us how to tell if that rate is above or below the natural rate).
Rob Rawlings, what Lachmann showed was that once you pick the numeraire, then the rates of return in barter are pinned down (in equilibrium) no matter what good you invest in.
But that number can be different, depending on which good you pick.
So if there are n goods, in principle there could be n equally good “natural rates of interest,” even accounting for Lachmann’s point. So when Hayek says the banks charge a money rate less than the natural rate, you can’t look at the equlibrium barter economy and tell me what “the natural rate” is supposed to be, even in principle.
Look: Glasner’s abstract summarizes Lachmann’s “contribution” quite well. The way Glasner (and co-author) put it, Lachmann (and Keynes) showed that you pin down the natural interest rate in a barter economy “up to a scalar multiple.” That means you can multiply “the” natural rate by any real number you want.
Suppose I told you I was going to pay you a certain amount to cut my lawn, “up to a scalar multiple.” I told you $10 originally, then I paid you $2, because I multiplied by the scalar of one-fifth. Do you feel comfortable with that pay arrangement?
Suppose I’m in the cheese sandwich business.
Under Barter:
I borrow some cheese and I borrow some bread. If the price of bread (relative to cheese) is going to change between now and when I pay the loan back then the interest rate on bread will differ from the rate on cheese. I make the sandwiches and barter them for bread and cheese which I use to pay back the loans (in bread and cheese) and make some profit.
Under a monetary-system
The holders of cheese and bread sell their product for money
I borrow that money at an agreed rate of interest
The price of bread changes (as under the barter example)
I make and sell my sandwiches and pay the money back
At equilibrium: With the interest plus capital they get back the lenders could (if they choose) buy exactly the same amount of cheese and bread as they got back under barter. Money was just a veil. The interest to the bread seller will be the same as the interest to the cheese seller – this just buys different relative amount of cheese and bread as a result of the change in their prices during the loan period
At disequilibrium: If prices of bread and cheese are out of equilibrium then this will open arbitrage opportunities for businesses. If the money rate is below the natural rate then I will borrow more bread and cheese than I would under barter and there will ABCT in the sandwich market.
What is wrong with my analysis? How does choice of numeraire change this?
Replies are not appearing in line. This is about Bob R’s sandwhiches. When the price of cheese varies in your money example, then to keep ceteris paribus the price of bread should too shouldn’t it, or the amount of cash you have should. Otherwise you are introducing another effect, to unparibus your ceteris. I haven’t worked out if this changes your analysis. But my question is, does it?
Rob have you gone and looked at my section in the linked paper? I walk through a 3-good economy with numbers and show exactly what I mean about the rate of interest being different, depending on numeraire.
Yes, And in each case they are different because of expected future value changes (and there is no originary interest involved in your example).
Each good has its own-rate based on expected future value but it is easy to see how they can be equilibrated.
So when you say this in that paper I disagree.
“As this simple example demonstrates, when the natural or own-rates of interest differ on individual commodities, there is no way to isolate a unique natural rate of interest for the economy as a whole.”
Assuming there is an underlying originary rate then all own-rates will be this rate adjusted for changes in relative prices.
You then say
“By specifying a basket of commodities to serve as a price index,
one can certainly obtain a unique number, but the construction of such a basket is largely
arbitrary and has no intrinsic relation to issues in capital or interest theory.”
I disagree this is a serious obstacle. This is exactly the situation we face in a monetary economy. The interest rate needs to reflect both the originary rate and expected future price changes. Each individuality will calculate their own index based upon their own spending patterns and expectations. This combined with their own time preferences will then determine there desire to lend/borrow money at various rates of interest. This will then lead to a market demand and supply curves for loans equilibrated by the “natural” rate of interest.
Bob,
While waiting for you definitive post on this I wanted to add one more comment to this thread
1. When you say above “”you can’t look at the equilibrium barter economy and tell me what “the natural rate” is supposed to be, even in principle” is a true statement”. However Lachmann did demonstrate that all rates in the economy in equilibrium would be set to the originary rate plus expected value change for each commodity.
2. While true the above statement is irrelevant to a monetary economy in regards to ABCT as only the monetary rate of interest comes into play there. The loan market in equilibrium will factor in all participants .originary interest requirements and expectations about future prices. The resulting interest rate will be the “natural” rate.
3. ABCT arises when the CB causes the loan market to go into dis-equilibrium by increasing the money supply and disturbing people’s expectations about future prices. This will lower the interest rate below the natural rate and cause the distortions it is associated with.
Rob, I think you are a little off in your (1) and (2), but actually your (3) is pretty close to what I was trying to do in my rehabilitation / extension of Hayek’s response to Sraffa.
Just to be clear, everybody, I still “believe” ABCT. I just think that the Austrians never gave an adequate response to Sraffa, and for sure I can understand why mainstream people reading that exchange would think Sraffa tore Friedrich a new one.
“I think you are a little off in your (1) and (2)”
It would be helpful if you could explain where I am off
I have read your paper and I thought I was actually agreeing with you on (1) and that (2) was where I disagreed with (or perhaps just mis-understood) your view
Rob I’m getting ready for a long trip so I probably can’t come back to this. I’m hoping to do a completely new post once I think through exactly what Gene is saying.
ok
Have a good trip.
But Bob, Isn’t the point that in a money economy, money being one of the commodities, talking of interest rates in terms of money means you have pinned down the commodity? And by your own argument, does the rest not follow?
Anonymous, so a boom occurs when the money rate is below the money rate?
Just to not be so snarky, anonymous: When you pick the numeraire, then its own natural rate becomes the single rate of interest in all commodities.
So, if you say, “OK Bob, in our economy right now Federal Reserve Notes are the numeraire. We price everything in terms of its exchange ratio against the USD. Now that we’ve picked a numeraire, Lachmann teaches us that we have a unique natural rate of interest in all commodities. So what is the natural rate to which we should set the nominal rate of interest?” then my answer is:
The nominal rate of interest IS the natural rate of interest on US dollars. That’s what “natural rate” means; how many future units of the commodity in question do you get, by selling one present unit? So if 100 dollars today trade for 105 dollars next year, then the natural rate of interest on Federal Reserve Notes is 5%.
So no, telling me to pick the USD as numeraire does nothing to solve the problem. It would make Hayek’s concern literally impossible to come true; the money rate is always equal to the natural rate, if we define “natural rate” as the one resulting from choosing the USD as numeraire.
Gene says your model ignores originary interest. What you say here is consistent with that view. Is it not originary interest (plus expectations of it future purchasing power) that makes the interest rate 5% not the picking of fed notes as the numeraire.
Gene says your model ignores originary interest. What you say here is consistent with that view. Is it not originary interest (plus expectations of it future purchasing power) that makes the interest rate 5% not the picking of fed notes as the numeraire.
Rob, even if Gene’s objection were valid (I’m not saying if it is or isn’t), that doesn’t affect what you and I are doing here in our exchange. I said what Lachmann’s view was, then you said OK Bob, then given his view, we know what the numeraire is, so what’s the problem?
Then I told you the problem, and now you are switching to Gene’s blog post. Are you admitting that my interpretation of Lachmann, if correct, shows Lachmann contributed nothing to the debate, and now you’re switching objections?
(I realize the above may sound testy or hostile, and it’s not meant to be. This is a very confusing topic, so I’m trying to get you guys to see why–in my opinion–we just keep going around in circles. I answer one objection, then you bring up a different one, I answer it, and then you go back to the first one, all the while thinking you are maintaining the same basic objection.)
To clarify: I wrote my comment (with the sandwich model) and look forward to your response.
I then read your response to Anonymous – and thought that reflected the originary interest issue and commented on that totally separately.
For some reason both my 2 comments got posted inline and I agree that makes it look as though I am switching tracks. ignore the comments that refer to Gene’s post if that helps.
I really am hoping to solve this issue via this dialogue.
And no, I don’t even claim to understand your view yet. I think if you could tell me where you think I went wrong in the sandwich model it may help.
What I’m going to do, Rob, is try to have official blog responses with Gene. I don’t want to ignore his originary interest point, but I’m not sure he is grappling with the problem I’m raising.
Sufficient but not necessary …
(wait for it)
That comment is msiplaced. It was supposed to go on Bob’s “Anonymous, so a boom occurs when the money rate is below the money rate?”
“no monetary system where capital goods investments are made by means of money can hit the right equilibrium natural interest rate on each in natura loan of various capital goods, because there is no such thing.”
A monetary system, per Hayek, does not have to hit any of these. It needs to hit that money rate of return that would leave these different equilibrium natural rates of interest in equilibrium with each other and not trigger arbitrage movement of capital across lines producing different commodities. Even if the money rate of interest differed from that money rate of interest, arbitrage action would force it towards that level (unless of course you explain why it will not). So I fail to see any sense in your objection.
“According to the logic of Hayek’s theory, it follows that there is therefore no way in principle for a monetary system of lending for capital goods purposes to achieve intertemporal coordination.”
False if you just consider the point that the system just needs to be able to zero in on the correct money rate of interest and that any other money rate of interest will trigger arbitrage action that will enable the discovery of the correct money rate of interest. For the third time, please explain why this arbitrage action will not happen.
“(4) But in a world of heterogeneous capital goods which is out of general equilibrium, there could be as many natural rates on each commodity considered as a capital good as there as such commodities.”
I think this is where the confusion is entering the discussion.
My view is that if these ” heterogeneous capital goods” are being used to issue loans then there would indeed be multiple own-rates. And Lachmann explains how the market resolves this issue.
If all loans are made in money and used to buy ” heterogeneous capital goods” there would not be multiple own-rates – but just one core rate for money (and of course actual rates would vary around this based upon risk).
It is is this money rate – that if not set correctly can lead to ABCT – but (unless I’m missing something here) that is not related to multiple rates in a barter economy.
(1) False. Natural, or originary interest is the difference in valuation between present and future goods, in both a barter and monetary economy. It is not the interest rate on loans.
(2) This “rate” applies to monetary economies as well
(3) OK
(4) No, the natural rate is singular because it is the single individual’s time preference. It is manifested in various rates on various commodities. Natural rates are not inherent in the goods. It is wrong to say that there are many different interest rates because there are many different goods. It is correct to argue that there are many different interest rates because individuals manifest their singular time preference of present goods over future goods in a complex of “rates” on goods and money loans.
(5) All the more reason why the Fed can only distort the economy through interest rate manipulation.
(6) Doesn’t matter.
According to Hayek’s theory, there is no way for a central bank to successfully target “the right” interest rate.
There is no implication whatsoever of abolishing money in Hayek’s theory.
Tendencies towards equilibrium are not “unrealistic.” Beliefs that economies can be fixed in a state of disequilibrium, based on the belief that economies don’t tend to equilibrium, are unrealistic, because beliefs that economies can be “stuck” in disequilibrium, is just another equilibrium proposition.
No need to click on your link, because your statements here are flawed enough.
May I suggest that the problem isn’t as big as you and Sraffa seem to think it is. At least, in the particular case of the quote: “when you say the central bank should set the money rate to the natural rate, I guess it has to set the nominal rate of interest equal to different numbers, simultaneously”, it really isn’t much of a problem.
Here in Australia, the Reserve Bank “cash rate target” right now is 3.0% so can I as an Australian borrow money at 3.0% ? Heck no! Would I as an Australian lend money at 3.0%? No way! So what does that 3.0% actually mean to Australians? Not much. Thing is, the RBA only has a small number of select customers that the 3.0% applies to, and this “cash rate target” is only for one purpose, which is overnight settlements. That’s a very, very limited part of the overall money market in Australia.
The consequence for the theory is that Hayek can be perfectly correct that a unique “natural rate” exists in the narrow confines of Reserve Bank activity, and at the same time also be perfectly correct that the larger part of an economy supports multiple interest rates.
Agreed. “The” natural interest rate can be interpreted as “the” rate the central money printer targets. For the Fed, it’s “the” rate on overnight loans.
But like you said, the CBs don’t just affect one interest rate even if they only target that one loan type. Their activity affects many interest rates on many loan types.
Like Bala said, the chances of CBs setting off unsustainable booms is therefore heightened, because now there are many more interest rates they can make mistakes in.
” The” natural interest rate can be interpreted as “the” rate the central money printer targets. “
No, it can’t. The natural rate of interest is a non-monetary theory of the interest rate Mises and Hayek borrowed it from Wicksell:
“Wicksell treated the natural rate of interest as a real rate of interest in the sense that it equated the forces of productivity and thrift, as if saving and investment were undertaken in real goods (in natura) …. . Monetary equilibrium was said to exist when the market rate of interest, determined in the market for credit, equaled the natural rate, determined by the real forces of productivity and thrift. Any discrepancy between the market and natural rates produced cumulative inflation or deflation.” (Rogers, C. 2001. “Interest rate: natural,” in P. Anthony O’Hara (ed.), Encyclopedia of Political Economy. Volume 1. A–K, Routledge, London and New York. 545–547 at p. 545).
““Wicksell treated the natural rate of interest as a real rate of interest in the sense that it equated the forces of productivity and thrift, as if saving and investment were undertaken in real goods (in natura) …. . Monetary equilibrium was said to exist when the market rate of interest, determined in the market for credit, equaled the natural rate, determined by the real forces of productivity and thrift. Any discrepancy between the market and natural rates produced cumulative inflation or deflation.” (Rogers, C. 2001. “Interest rate: natural,” in P. Anthony O’Hara (ed.), Encyclopedia of Political Economy. Volume 1. A–K, Routledge, London and New York. 545–547 at p. 545).”
I said it CAN be interpreted that way.
I didn’t say Mises interpreted it that way.
Right: neither Mises in his early work (before Human Action) nor Hayek in “Prices and Production” defied the natural rate in the way you do.
Therefore your post above does not refute what Murphy has written above, for it simply evades the issue by redefining what Hayek meant by the natural rate.
“for it simply evades the issue by redefining what Hayek meant by the natural rate”
Actually, whichever of these Hayek meant, Sraffa’s criticism actually stands destroyed. That, in case you did not follow, is the core. So stop trying to deflect the discussion.
And, I forgot to add, what is left standing is Sraffa’s unintended strengthening of Hayek’s point.
Hope you sleep well now.
Glad you agree that the concept of a natural interest rate CAN be interpreted in a way that differs from Mises.
It’s not an evasion, because I have also addressed the Sraffa-Hayek interpretation directly as well in this thread.
You are evading the separate argument that the natural interest rate can be interpreted as the rate the CB targets.
“You are evading the separate argument that the natural interest rate can be interpreted as the rate the CB targets.”
What rate? Outside equilibrium there are many rates. Which one is it targeting?
LK,
Stop evading the core point. The very fact of targeting in the face of multiple rates means that the CB CANNOT get it right in terms of all rates. If it is right for rate x, it must be wrong for rate y.
Sraffa ended up strengthening Hayek’s point. Face it.
What natural rate? The rate the Fed targets. The Fed funds rate.
This rate CAN be interpreted as “the” rate the Fed deviates away from “the” natural rate.
If the Fed bring the Fed Funds rate down below its natural rate, then, also taking into account the implications of this, we can argue that this generates unsustainable booms.
The core of ABC is that the CB bringing down interest rates, (or the interest rate, it is not that important), it influences economic calculation and results in investors starting projects that require more real savings than are available (and as a corollary requires more real savings in the future, since future real savings are a function of current real savings).
Investors, since they are faced with non-market interest rates, are misled and invest as if the requisite real savings are and will be available, when they are really not.
This core of ABC is not at all seriously undercut by splitting up “the” natural market rate into a series of natural market rates. We just need to add an “s” to every time the word “rate” is used.
“The core of ABC is that the CB bringing down interest rates,”
No, it isn’t: any FR banking system, or indeed any monetary system with negotiable credit instrument in sufficient quantities would – according to the logic of the theory – do it.
The only way to equate the real savings with investment – in the vast mass of commodities lent for capital goods investments – is if you abolished money: no monetary system can possibly allow the existence of multiple monetary rates targeting the natural rate of each commodity loan made as if in natura.
“The only way to equate the real savings with investment – in the vast mass of commodities lent for capital goods investments – is if you abolished money”
You’ve already said this falsehood once, do you really think it will be something other than false if you say it again?
It is not true that the only way to equate nominal interest rates with natural interest rates is to abolish money.
Private property protections (prohibition on negative externalities) is sufficient.
You keep insinuating the falsehood that anarcho-capitalism necessarily has FR banking.
With enough people realizing the negative externalities of FR banking however, it is possible for FR banking to be outlawed even in an anarcho-capitalist society.
You yourself can’t even regard FR banking as a logical implication of private property rights societies, since you’ve already accepted that it has negative externalities.
(1) so now your argument is: if we just abolished fractional reserve banking, then there would be no ABCs (according to the logic of the theory).
False: as I said, any monetary system with negotiable credit instrument in sufficient quantities would – according to the logic of the theory – do it.
You have to outlaw negotiable cheques, negotiable bills of exchange, negotiable promissory notes, and any and every negotiable credit instrument.
(2) The existence of some contingent negative externalities does not necessarily make something immoral at all.
(1) You can’t refute the argument that no FR would lead to no ABC by proposing a scenario WITH FR. You said “monetary system with negotiable credit instrument in sufficient quantities”. That is presupposing credit expansion, which is FR.
(2) Recessions are not “contingent” given that nominal rates are brought down below their natural rates, which is the context to which ABCT is intended to apply. Also, the existence of necessary harm to third parties caused by activity X makes activity X immoral. “Some” and “contingent” are not relevant to FR or CB in a context of ABCT.
Ad Rothbard pointed out, there were two phases in achieving our present day system: first the banks needed to be allowed to perform fractional reserve banking at all (for example grain silos are explicitly forbidden from doing the equivalent), but second, the Central Bank (together with government fiat) acts to organize a legally enforced banking cartel, and the banks need this ability to extend their fractional reserve banking on much thinner reserves than they would ever get away with without the cartel to protect them.
So yes it is possible for other entities to offer credit, but not in the same way that the banks can do it at the moment.
It is estimated that around the early 19th century, bills of exchange were about 70 % of money supply in Western nations.
So much for the idea that “other entities” offering “credit” weren’t significant before FRB.
Read closer. Hayek explicitly says this is impossible.
“HAYEK: To avoid causing an unsustainable boom, the monetary authorities should set the money rate of interest equal to the natural rate.”
Based on Lachman he should actually have said ” the monetary authorities should set the money rate of interest equal to the natural rate adjusted for the expected rate of inflation”
That’s circular given that the same monetary authorities are the ones responsible for controlling inflation.
Admittedly the present system doesn’t work too well, so no doubt there are reasons for that.
A smart CB would both set expectations about inflation and meet those expedctatiosn
They would meet expectations as well as expedctatiosn
Wouldn’t they know that they’re lowering the interest rate if they’re adding to the monetary base?
1. Suppose the Bank of Canada were targeting 0% CPI inflation rather than 2% CPI inflation. Would it need to set a different path of nominal interest rates? Yes.
2. Suppose the Bank of Canada were targeting 0% cellphone inflation rather than 0% CPI inflation. Would it need to set a different path of nominal interest rates? Yes.
3. Would the vector of real interest rates be different across those 3 monetary policies? Maybe, maybe not. Depends on whether prices are sticky and money is superneutral.
the price established in the market for a good is not the same as the price that all buyers and sellers independently would pay or receive absent the market but the market process settles at a price that will suit some more than others.. maybe this is a bad comparison but isnt this the same with the natural rate of interest. There may be internal levels that individuals would wish to pay/receive but the market establishes a rate… i.e. Sraffa’s point is misdirection, sure there are countless subjective rates but only one actual rate?
Which is why, in certain special markets (like the inter-bank overnight lending market) where only particular participants are allowed, the price can be very different to what it is in the broader market.
There is a further dimension to all this that doesn’t seem to be getting any attention.
The central bank CAN in theory set “a” rate of interest equal to “the” natural rate, if by “the” natural rate we mean the rate of interest on overnight loans specifically (the Fed Funds rate).
There is no multiple rates of interest on overnight loans, so Hayek’s point that the only way the Fed can avoid an unsustainable boom is if it sets the fed funds rate equal to the unhampered free market overnight rate, (and borrowing from Bala), is not challenged by pointing out that there are multiple own rates on goods in general.
Or, even more to Bala’s point, if the Fed is not able to target ONLY a “correct” Fed Funds rate, by virtue of the fact that targeting a specific Fed Funds rate will inevitably have side effects on other interest rates relating to other goods, thus deviating those rates from their “own rates”, then Hayek’s point is only emphasized. For if it is impossible for the Fed to only influence one interest rate (Fed Funds rate) when it inflates, then it will deviate all of the various multiple own rates from their unhampered free market values. Unsustainable booms are not only likely, but virtually certain.
I think the reason why Sraffa’s criticism (i.e. the Fed cannot set a bunch of rates simulatneously) is being given any serious consideration at all is likely due to the fact that Sraffa and his central planning ilk are only engaged in debates to figure out how the Fed should be run. So when he hears Hayek say the Fed has to target the natural rate if it is to avoid unsustainable booms, Sraffa the central planner thinks to himself “How can the Fed DO things better given what Hayek has said? The answer is they can’t do things better, and that’s all that matters. Since Hayek’s recommendation is not possible, it must mean Hayek is wrong about interest rates. The Fed can only target one rate. Oh, and just to throw this in there, Hayek’s whole theory must be wrong too.”
Bala is right. Sraffa’s “criticism” is in fact a strengthening of Hayek’s point. Hayek’s point is that the Fed can only avoid an unsustainable boom if it sets the nominal rate equal to the natural rate. If there is not one but multiple natural rates, then the Fed is ipso facto faced with an even greater difficulty. For instead of just making a mistake with one interest rate, the Fed, because its inflation affects many different interest rates and not just the Fed Funds rate, can make MANY mistakes with MANY interest rates.
How’s that for irony?
Yes, Austrians might want to integrate multiple interest rates into their analysis. But it would be more of an exercise in putting a cherry on the cake that Sraffa has already baked for them. “Put that cherry on the top Austrians, if you know what’s good for you!”
Hahaha
If there is not one but multiple natural rates, then the Fed is ipso facto faced with an even greater difficulty.”
If there is not one but multiple natural rates, then free banks are ipso facto faced with an even greater difficulty: their interest rate spread converges owing to competition, and they could not target multiple natural rates either, especially when multiple natural rates could have a large spread between them.
“…either…”
I’m glad you agree that Sraffa’s “criticism” actually strengthens Hayek’s argument.
It’s also interesting that you are claiming that “free banking”, since it causes unsustainable booms (and thus recession and unemployment) is NOT solely “voluntary activity between consenting adults”.
For if you claim that free banking has negative externalities, then you can’t also claim that free banking is a purely “respect for private property” activity, and hence NOT an institution in anarcho-capitalism.
So you are inadvertently concluding that there are no monetary caused booms and busts in anarcho-capitalist societies that protect against negative externalities.
In a society that protects individual property rights, A and B cannot “voluntarily” agree with each other in such a way that their activity harms C.
This is better wording:
“For if you claim that free banking has negative externalities, then you can’t also claim that free banking is a purely “respect for private property” activity. Hence “free banking”, to the extent it causes unsustainable booms like you say, is NOT an institution in anarcho-capitalism.”
(1) no, I do not accept the truth of ABCT, so I’m hardly saying it causes “unsustainable booms” in the sense you think
(2) “For if you claim that free banking has negative externalities, then you can’t also claim that free banking is a purely “respect for private property” activity, and hence NOT an institution in anarcho-capitalism.”
First, the existence of negative externalities caused by an act does not make this act immoral under the ethics of Rothbard or Hoppe.
Natural rights ethics does not say that something is immoral just because it was negative externalities.
Only utilitarianism / consequentialism says that if something has negative consequences (including negative externalities) that outweigh positive consequences, then one can make a case for its immorality.
(3) In a society that protects individual property rights, A and B cannot “voluntarily” agree with each other in such a way that their activity harms C.
That is manifest nonsense.
Person A and person B in a Rothbardian society engage in a fully free and voluntary transaction whereby A buys a gun from B.
Later A commits a crime and kills person C.
Rothbardian ethics does not say selling guns or even the individual transaction I’ve just imagined is immoral, idiot.
(1) Then your implicit claim that free banking generating unsustainable booms collapses.
(2) The existence of harm to C, due to A and B agreeing with each other to contract, actually is considered immoral under both Hoppean and Rothbardian ethics. For both ethical systems do not arbitrarily ignore every individual except the two individuals in a given contract/exchange. They both include all individuals and all property rights simultaneously, despite pedagogical examples that usually consider just two individuals who are contracting/exchanging. In fact, one of the reasons Hoppe himself gives for why he is against “free banking”, an hence why “free banking” is anti-Hoppean ethics, is precisely due to the negative externality harm that it generates. Natural rights ethics actually DOES include the proviso that A and B “agreeing with each other” in such a way that harms C, is in fact immoral. You are flat wrong to assert the opposite. Natural rights is concentrated on the individual, all individuals, not just the two parties you are observing or considering as a thought experiment in making an exchange. You are pathetically wrong to claim that “only consequentialist ethics” considers harming third parties “immoral”. It is ironic because natural rights ethics holds an absolute prohibition on harming third parties, while consequentialist ethics holds that harming third parties NOW can be morally just, if the outcome in the FUTURE is desirable (to individuals, or the majority, or whatever).
(3) That is also flat wrong, and your alleged counter-example is garbage. If A and B trade their property whereby A buys a gun from B, then A later shooting C is NOT a necessary causal outcome of A buying a gun from B. It is a separate, NEW decision that has its own ethical implications. Thus it does not serve as a counter-example to the Rothbardian ethical prohibition on negative externalities. A and B agreeing to trade a gun for money does not have the negative externality of A shooting C, for that is a separate, new decision by A.
A shooting C is NOT a negative externality of the exchange between A and B.
Negative externalities of exchanges are constrained to the exchanges themselves. They do not include new decisions made after the fact.
(1) A negative externality does not have to be a necessary consequence of the original market exchange at all. It could be – and in the real world often is – contingent.
(2) So what you now what to say is: Hoppe’s and Rothbard’s ethics say that necessary negative consequences of market exchanges make those exchanges immoral.
Apart from the fact that this is a consequentialist moral precept, the business cycle is not even a necessary consequence of free banking or central banking.
The business cycle effect is contingent : resulting from the failure to hit (as you suggest earlier) a natural rate, which could in fact have been hit.
LK,
You are repeating the same mistake
“a natural rate, which could in fact have been hit.”
With multiple natural rates, hitting one rate means missing the others. That means that the unsustainable boom is inevitable.
(1) You’re evading the point you yourself raised. If the negative externality IS a necessary implication, which Hoppe and Rothbard both argue is the case with “free banking” and unsustainable booms, then the recessions and unemployment from “free banking” that you implicitly admitted takes place, ARE a negative externality and thus ARE immoral in Anarcho-capitalist/Rothbardian/Hoppean/Natural rights ethics.
(2) I didn’t “now” say that. You did. You said “…either…” in the post above, and that suggested that you believe free banking generates unsustainable booms. Well, if you believe free banking generates unsustainable booms, then you are equivalently saying free banking has necessary negative externalities.
(3) Negative externalities is NOT monopolized by consequentialist ethics. Private property ethics also prohibits A and B “voluntarily” agreeing with each other, without violating their own property rights, in such a way that their activity harms third parties in a necessary, not contingent, relationship. Both Rothbard and Hoppe ethics (which are both private property ethics) prohibit A and B agreeing with each other that through that activity harms C, even if A and B do it unintentionally.
(4) You’re confused. ABC is not “contingent”. It is not a theory of mere EXISTENCE of CBs, where they may target the right rate or rates. It is a theory that focuses on cases where nominal rates are brought down below their natural rate or rates. ABC doesn’t take place otherwise. Given that the rates differ, then ABC is considered necessary. ABC isn’t a theory of everything. It is a theory about what happens when the rates differ, and why there are recurring cycles historically.
Yes, obviously the natural does not exist, which means:
(1) that a free banking system cannot hit multiple natural rates either, for there could be as many natural rates as there are commodities, and free banking rates are just a spread of monetary rates converging basically due to competition.
(2) the way the system fixes itself (according to the Hayekian theory) is to let the market monetary bank rate converge to the natural rate. But there is no such single natural rate, only multiple ones
Which natural rate does a bank rate converge to in order to restore equilibrium?
LK,
It is clear that you have not heard of the concept “arbitrage”
See below:
“Lachmann’s demonstration—that once we pick a numéraire, entrepreneurship will tend to ensure that the rate of return must be equal no matter the commodity in which we invest—does not establish what Lachmann thinks it does. etc. etc
LK,
See my 2nd post on this thread. I explained why Bob is wrong. So stop citing him in support of your claim.
(1) The natural rate does exist. It just doesn’t exist within commodities in the context of the Sraffa-Hayek debate. There is no single natural rate on commodities that manifests in the same interest rate on all loans in barter. But originary interest is a single “rate” that describes the intensity of an individual’s desire for present goods as such relative to future goods as such. This intensity manifests in a complex of nominal interest rates on various loans depending on their relative marginal utilities. But the originary interest is the same because it’s the same individual. For individuals in cooperation, hampered by CB/FR, the complex of rates do not reflect the single individual rates of time preference. A CB could not target any natural rate rates even in principle, because they cannot observe how intense your desire is for present goods over future goods.
(2) “The way the system “fixes” itself” is a flawed way of looking at other individual people. The way social cooperation in a division of labor can avoid unsustainable booms is to avoid deviating interest rates away from where individual time preferences would have put them. Whether it’s a state money printer, or dishonest bankers/clients, is subsidiary.
Defining the natural interest rate as “the” interest rate that would prevail in a barter economy is a bad approach.
Who cares about advanced market economies that solely use barter? They are just imaginary.
I would define the natural interest rate as a money interest rate in a money economy. It is one that coordinates saving and investment. It is like an equilibrium price, but not the one that just clears the supply and demand for credit. Or rather, it is only equal to that interest rate in the absense of monetary disequibrium.
If the price level is prefectly flexible so the real quantity of money equals the demand to hold it, then the market rate that clears credit markets coordinates saving and investment. Or if the nominal quantity of money adjusts with the demand to hold money, then the market interest rate that clears credit market is the natural interest rate.
But, if the quantity of money fails to meet the demand to hold money (at potential output) then the interest rate that clears credit markets is not the natural interest rate. In particular, an excess supply of money can result in a market rate below the natural interest rate.
If you don’t even begin to treat it as some kind of unchanging constant, then I am not sure what is the problem?
It is mostly about coordinating expectations. In particular, the natural interest rate is not necessariy the relative price of consumer toods to the marginal physical product of capital, or the real rate of proft that can be earned, or anything like that.
Like Rowe, I think it does depend on the monetary regime. I hadn’t tought much about the different price index issue, but I do think the amount of outside real money balances held makes a difference. Pure credit money systems probably have a lower natural itetrest rate than a commodity money system. And higher reserves and lower inflation results in a higher natural interest ratre still.
But maybe it is more complicated than I undestand.
“I would define the natural interest rate as a money interest rate in a money economy. It is one that coordinates saving and investment. It is like an equilibrium price, but not the one that just clears the supply and demand for credit. “
Simply redefining it does not answer the question whether Sraffa’s critique of Hayek was right. It’s just changing the subject.
Nobody is obligated to only submit posts that “answers” that particular question, LK. Quit being a debate Nazi.
This is a “spontaneous order” blog. Yes, we know that baffles you.
We have plenty of real world examples.
The Australian mortgage rates are higher than the US mortgage rates, not just a momentary spontaneous thing, but this has been the case for a decade or more. Worse, the Australian dollar has trended upward in comparison to the US dollar over the same period, so if you follow Murphy’s theory it predicts the exact opposite of what we observe.
And, yes to all intents and purposes, exchange of fiat currencies at the global scale works exactly like a barter economy.
Being thought of as wrong by Callahan and Glasner is, if history is any guide, a strong signal that you are on the right track.
Not sure about this particular debate yet though.
I could have sworn you were about to do a time-series regression on me, MF.
So long as you have “monetary authorities”, there are going to be problems because the “monetary authorities” are never going to have sufficient information to mimic the “natural rate” or the “natural rates” as the case may be. As Hayek said in 1975:
“The primary cause of the appearance of extensive unemployment, however, is a deviation of the actual structure of prices and wages from its equilibrium structure. Remember, please: that is the crucial concept. THE POINT I WANT TO MAKE IS THAT THIS EQUILIBRIUM STRUCTURE OF PRICES IS SOMETHING WHICH WE CANNOT KNOW BEFOREHAND BECAUSE THE ONLY WAY TO DISCOVER IT IS TO GIVE THE MARKET FREE PLAY; BY DEFINITION, THEREFORE, THE DIVERGENCE OF ACTUAL PRICES FROM THE EQUILIBRIUM STRUCTURE IS SOMETHING THAT CAN NEVER BE STATISTICALLY MEASURED.
****
In contrast, the modern fashion demands that a theoretical assertion which cannot be statistically tested must not be taken seriously and has to be discarded. As a result of this belief, a theory which, in my opinion, is the true explanation has been discarded as not adequately confirmed, and a false theory has been generally accepted merely because it happens to be the only one for which statistical evidence, even though very inadequate evidence, is available.”
The “natural rate” or “natural rates” are prices “WHICH WE CANNOT KNOW BEFOREHAND BECAUSE THE ONLY WAY TO DISCOVER IT IS TO GIVE THE MARKET FREE PLAY; BY DEFINITION”.
http://www.flickr.com/photos/bob_roddis/7534880182/in/set-72157630494776170/
This is the same quote that LK constantly misconstrues because he has no comprehension of the Austrian concepts of economic calculation, the pricing process or “spontaneous order”.
Hayek should have originally said: “You are right. There is really no way that the monetary authorities could ever possibly mimic the “natural rate” or the “natural rates” of the market.
(1) that quote from Hayek is talking about equilibrium prices and wages, not interest rates, nor natural rates of interest.
(2) this is the perfect time for Robert Murphy to tell us whether he thinks that quote from Hayek is talking about a market tendency to equilibrium prices and wages (that is, market clearing prices).
You are either lying, clueless, or both, LK. Hayek is talking about essential Austrian insight that neither prices nor interest rates (which are prices) can be known in advance of the actual transaction.
The “natural rate” or “natural rates” are prices “WHICH WE CANNOT KNOW BEFOREHAND BECAUSE THE ONLY WAY TO DISCOVER IT IS TO GIVE THE MARKET FREE PLAY; BY DEFINITION”.
Unfortunately for you Central Planners, life is non-ergodic.
There’s no reference whatsoever to the natural rate in that Hayek quote.
For the third time this hour:
The “natural rate” or “natural rates” are prices “WHICH WE CANNOT KNOW BEFOREHAND BECAUSE THE ONLY WAY TO DISCOVER IT IS TO GIVE THE MARKET FREE PLAY; BY DEFINITION”.
No, monetary rates even in a free banking system cannot hit multiple natural rates (which could be as numerous as the number of commodities).
So even that argument does not work.
The only way is abolish money, which just means a return to a barter system.
Arbitrage
You again assert that “free banking” generates negative externalities.
No, that doesn’t work:
“Lachmann’s demonstration—that once we pick a numéraire, entrepreneurship will tend to ensure that the rate of return must be equal no matter the commodity in which we invest—does not establish what Lachmann thinks it does. The rate of return (in intertemporal equilibrium) on all commodities must indeed be equal once we define a numéraire, but there is no reason to suppose that those rates will be equal regardless of the numéraire. As such, there is still no way to examine a barter economy, even one in intertemporal equilibrium, and point to “the” real rate of interest.”
Murphy, “Multiple Interest Rates and Austrian Business Cycle Theory,” p. 14.
LK,
In case you read what I wrote, I just showed that Bob was wrong. Citing him does not help.
“but there is no reason to suppose that those rates will be equal regardless of the numéraire”
Of course there is a reason. The time preference of individuals for consuming goods AS SUCH. Those who have lower time preference, save more and consume less in the present. Those who have higher time preferences, save less and consume more in the present.
This is a human characteristic, not something inherent in particular goods versus other goods. It’s a singular concept. That is a good reason to suppose that there is a tendency towards “a” natural rate.
It can’t be measured statistically, but it has meaning and existence. It’s a category of thought.
For you non-Keynesians, it would be instructive to read pages 6-11 of the booklet containing the Hayek speech. He discusses how the only way to prevent the “monetary authorities” from causing trouble is to take away all of their powers.
http://www.flickr.com/photos/bob_roddis/7534880036/in/set-72157630494776170
BTW, the notes on the pages of the booklet came with the booklet.
(1) It doesn’t exclude interest rates. Interest rates are prices of goods throughout time.
(2) He doesn’t need to do that. Anyone who isn’t a moron understands that the market process includes the setting of interest rates.
Expect a post on LK’s blog trying to salvage something from this debacle. Considering the absence of a steady flow of replies, I guess he is doing just that. That’s how it has always been with him. When defeated, he runs to his blog, spews a lot of nonsense and throws in a huge mass of irrelevant data. Lo and behold! You have a refutation….
+1
My favorite part is when he thinks he can win through collecting arguments and statements.
Perhaps one day he’ll realize that rationalist epistemology is continually self-transcending and cannot be completed historically. Data alone is not enough. Understanding is necessary, and unobservable.
No wonder he’s constantly frustrated.
Far from defeating Robert Murphy, Sraffa or anyone else who points out that multiple natural rates undermine Hayek’s ABCT in “Prices and Production”, you’ve just demonstrated that your only counterargument is the clearly unsound tactic of redefining what Hayek means by the natural rate.
LK,
I did not redefine the natural rate. I just explained the logic and showed how the very existence of multiple interest rates strengthens Hayek’s position.
Bala, that’s it exactly. The more complicated reality actually is, the more it is impossible for the Central Planners to have sufficient information to even mimic that reality through their silly plans.
More evidence that LK* simply does not “get” the problem of knowledge.
Or any Keynesians/”progressives” for that matter.
That’s why reality just has to be simple for the socialists/progressives, doesn’t it?
With a simpler reality, (necessarily simple) central plans don’t seem as ridiculous.
Haha,
Hayek’s theory……in Prices and Production….on pages X, Y and Z…..said rate without an “s.”
Maybe one day you’ll realize that Mises originated the theory, and Mises’ theory…….in Human Action…..on pages X, Y and Z….said rates with an “s”.
But yeah, let’s pretend that only which LK has read is what we all have to consider. It’s much easier that way.
Anyone can play that game. Keynes’s theory….in The Economic Consequences of the Peace….on pages 235/236….said:
“Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become “profiteers,” who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds, and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.
“Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”
Let’s focus on this and claim that LK is “redefining” Keynesianism by saying it supports inflation.
Bob,
Gene’s explanation of this issue last week was very clear. There is an underlying “originary” rate of interest that will be the same for all commodities and each commoity’s “own-rate” will be this rate adjusted for future price changes (which would be reflected as the difference between the spot and future prices for each commodity”.)
Gene claimed he was merely restating Lacmann’s position.
In your own paper that you link to you state that you think Lachmann was wrong (or at least incomplete) in his rufation of Straffa:
“Lachmann’s demonstration—that once we pick a numéraire, entrepreneurship will tend to ensure that the rate of return must be equal no matter the commodity in which we invest—does not establish what Lachmann thinks it does”.
In addition your examples in that paper are inconsistent with Gene’s explanation – they show interest rates as derived purely from expected changes in prices and don’t include any “originary” rate (though this may just be because you were focusing on future price changes role in interest rate determination and ignoring originary interest for the sake of establishing that detail).
I don’t fully understand what you think Lachmann got wrong. He seems to provide a good explanation of why there will multiple own-rates and how they relate to each other so its unclear why you criticize for him for not explaining why there is not in fact only one rate of interest (when that wasn’t what he was trying to do!).
Based on this: Do you still stand by your paper ? What (if anything) do you disagree with in Gene’s explanation ? Would you now agree that Lachmann did indeed refute Straffa on this issue ? If not, can you try and explain again where Lachmann (and gene?) got it wrong ?
I always considered originary interest as a singular logical category of thought, which manifests itself in interest rates on loans and on own rates of interest on commodity trades in barter.
I don’t accept the implicit argument that there is something inherent in each commodity that causes the rates to differ such that we observe the rate on tomato loans to be different from the rate on potato loans.
I consider originary interest to be a singular concept that describes how intense an individual’s desire for present goods as such relative to future goods as such.
If in a laissez faire barter society I were to loan tomatoes at 5%, but potatoes at 10%, then this doesn’t represent a case of different natural interest rates on tomatoes and potatoes. The originary interest is the singular intensity of my desire for present goods. It is the cause for me to lend tomatoes at interest at all and to lend potatoes at interest at all.
The 5% and 10% are different because of the different relative marginal utilities I attach to tomatoes and potatoes. It’s not because I am attaching two natural rates to them. The natural rate is the singular mental cause for why I am lending at positive rates for both. I prefer to have a given supply of tomatoes and potatoes sooner rather than later to a particular degree.
If my time preference ROSE, then the “natural interest rate” associated with me would rise, and I may desire to lend at 6% for tomatoes and 11% for potatoes, or even 5% for tomatoes and 11% for potatoes.
Sfraffa is sneaking in an objective value component, and Hayek was apologetic towards it because he more or less abandoned the rationalist foundation of economics that Mises taught him.
Hayek should have replied “There is nothing in the objects themselves that leads to different interest rates for them in barter. Those different rates are caused by differences in relative marginal utilities between those goods, not by any difference in originary interest, which is a singular mental category that manifests in interest in the first place.”
This single mental category can be communicated via a complex of interest rates, but the Fed, because it changes those interest rates, hampers the signals that derive from individual’s mental intensities for present goods as such.
I think Lachman would say in response to:
” So…when you say the central banks should set the money rate to the natural rate, I guess i they have to set the nominal rate of interest equal to different numbers, simultaneously?”
That if they lent out different commodities then this would be true, but if they lent only one kind of money (as is normal in a money economy) they would need to be concerned only with the rate of interest on that.
That if they lent out different commodities then this would be true, but if they lent only one kind of money (as is normal in a money economy) they would need to be concerned only with the rate of interest on that.
Guys, your responses to Sraffa at times seem to make an unsustainable boom logically impossible. OK, they are lending out some good as the money. Let’s say it’s Federal Reserve Notes. Now, what natural rate of interest on Federal Reserve Notes should they charge? This is also what most people call “the nominal rate of interest.” Rob Rawlings, you seem to be saying that as long as they just pick a numeraire, they’re fine. But no, Hayek himself said that if they set this natural rate of interest on Federal Reserve Notes below “the” natural rate of interest, then we have an unsustainable boom.
So, what number do they pick? There is no way you can, even in principle, define this, except (I think) to ask Major Freedom and Gene Callahan what the ratio is in their heads between a util now and a util next year, which Major Freedom’s own worldview says is a nonsense question (except when he’s discussing interest theory, in which case it’s orthodox Misesianism).
There, do I have any friends left? Good.
“So, what number do they pick? There is no way you can, even in principle, define this, except (I think) to ask Major Freedom and Gene Callahan what the ratio is in their heads between a util now and a util next year, which Major Freedom’s own worldview says is a nonsense question (except when he’s discussing interest theory, in which case it’s orthodox Misesianism).”
I wouldn’t use “util” though.
I would describe it as a singular desire for present goods as such relative to future goods as such. I am sure that this has meaning we can all agree with.
We have a choice. We could blow all our earnings on present consumption and no additional future consumption, or we could devote a portion of our earnings to investment and additional future consumption. The problem isn’t that we can’t measure this, it’s that we’re trying to measure it at all, which is necessary in order to give a response to Sraffa who also wanted this thing in observable terms.
The “natural interest rate” is a concept I regard as specific to the individual’s mind. I can say that you have a lower time preference than I do, or vice versa, but I can’t really put it into a single number like “Your rate is 5 units less/greater than my rate”. I could put it into a type of number, that is to say I could say that you are willing to lend money at a lower rate than I am, or I could say you are willing to lend tomatoes at a lower tomato rate than I am. Maybe you know more of what can be observed here.
For society as a whole, all the different mental “rates” for all individuals are only manifested in borrowing and lending money and goods when there are offsetting natural rates. For example we would only agree to me lending you money if your mental “rate” of desiring present goods offsets my own. If my mental “rate” of desiring present goods is even higher than mine, then we won’t agree to me lending you money. You need someone with a mental rate lower than yours.
For the ABCT thing, I don’t see how my responses imply it is impossible, for the mental “rates” that are manifested in a complex of observable loan rates can still be hampered, signal-wise, by a money printer affecting that complex of interest rates that will necessarily reflect something other than our mental rates for present goods as such relative to future goods as such.
I don’t have to tell you, but I’ll say it anyway, that as Mises pointed out, interest rates on money loans and interest rates on goods in barter are NOT originary interest rates, even in a pure laissez-faire economy.
“But no, Hayek himself said that if they set this natural rate of interest on Federal Reserve Notes below “the” natural rate of interest, then we have an unsustainable boom.”
As Hayek himself suggested the CB should target a constant MV (adjust M to accommodate changes in V).
In a model with expected changes in P then this would also need to be taken into account. So the CB should set interest rates to the level that allows MV to grow at the rate of expected inflation.
Of course this would still be an approximation but close enough to avoid boom/bust.
And if they set the rate below this then they could indeed get a ABCT-type boom
“As Hayek himself suggested the CB should target a constant MV (adjust M to accommodate changes in V).”
He also suggested countries should not have independent currencies.
Which Hayek is the one to listen to?
Hayek later suggested in “denationalization of money” that private currencies might emerge that would target maintaining their value against a specific price index. He acknowledged that this was sub-optimal compared to stable MV but he thought that it would led to only small deviations from the natural rate.
re:Since there is no unique price level in a barter system, a unique money natural rate of interest cannot be specified.
Doesn’t Gene’s example/claim refute this? What I took from his example is that, while there are as many different real rates of interest (as conventionally thought of) as goods/numeriares, there is a single originary rate of interest. And this is even in a barter economy.
Bob,
Your update makes it worse for you. The moment you talk of “a” money rate of interest lower than “the” natural rate, the “natural rate” is clearly what the money rate of interest would be in the long-term equilibrium.
Given this, Sraffa’s objection looks worse that in the earlier dialogue and your support for its relevance makes you look even worse. Arbitrage will force money rates on interest in all lines to be equal. And yes. As Gene said (and I did in a rather rambling way in the note I sent to you), the natural rate of interest is not just the ratio of spot and future prices. It is the price of waiting.
Bala wrote:
Your update makes it worse for you. The moment you talk of “a” money rate of interest lower than “the” natural rate, the “natural rate” is clearly what the money rate of interest would be in the long-term equilibrium.
And now my victory is complete. Bala just admitted that for Mises/Hayek interest theory to work, the commercial banks IN DAILY PRACTICE ought to set the actual nominal market rate of interest equal to something that would be true in “long-term equilibrium.” Should oil tycoons do the same with the spot price of oil?
“the commercial banks IN DAILY PRACTICE ought to set the actual nominal market rate of interest equal to something that would be true in “long-term equilibrium.” ”
Where doe what I said imply this???? I only said that the natural rate too is a money rate of interest. Hence, talking of “multiple rates” is meaningless. How you take this to mean what you do is a mystery.
*does
“And now my victory is complete. Bala just admitted that for Mises/Hayek interest theory to work, the commercial banks IN DAILY PRACTICE ought to set the actual nominal market rate of interest equal to something that would be true in “long-term equilibrium.””
Woah, I thought minimizing ABCs didn’t require nominal interest rates to BE their exact natural rates, on a daily basis, but only for them to TEND towards their natural rates, without ever reaching them, where the more they deviate, the more intense the business cycle will get.
You’re saying banks have to charge the exact equilibrium values. But then wouldn’t you be introducing equilibriums into where only tendencies are allowed? Mises and Hayek never said that nominal interest rates have to exactly be at equilibrium, did they?
Yup! My point too 🙂
Bala, when Hurricane Sandy hit, Bloomberg and Christie passed rules keeping gas prices at their long-run equilibrium levels. I insisted that entrepreneurs should have the ability to let prices skyrocket upward, temporarily, in light of a fleeting change of circumstances.
But you and MF thought I just gave an anti-Austrian response? Market prices tend towards what they will be in the ERE? What would NY and NJ gas prices be in the ERE? Certainly not what people were trying to charge when the hurricane hit.
“Bala, when Hurricane Sandy hit, Bloomberg and Christie passed rules keeping gas prices at their long-run equilibrium levels. I insisted that entrepreneurs should have the ability to let prices skyrocket upward, temporarily, in light of a fleeting change of circumstances.”
I would say Bloomberg and Christie did NOT set prices at “long term equilibrium values.” They set them at their arbitrary historical values (price controls).
They don’t know the long term equilibrium value of gasoline.
“But you and MF thought I just gave an anti-Austrian response?”
I am far less concerned with people toeing the so-called party line than I am with what I think is right. If you make an anti-Austrian argument that I think is right, then cool.
“Market prices tend towards what they will be in the ERE?”
I don’t think there is a single ERE. There can be a single theoretical ERE if we suspend people’s current desires, current knowledge, and so on. But these things are always changing, which means so is “the” ERE always changing, which means there is no “the” ERE. As soon as you think you got it, people learned something new and developed new preferences.
” What would NY and NJ gas prices be in the ERE?”
Given we suspend people’s knowledge and preferences? Given that we consider some other complex of knowledge and preferences? I haven’t the foggiest idea.
“Certainly not what people were trying to charge when the hurricane hit.”
If prices were free to fluctuate, then I would say that the prices that prevailed were ones that reflect a tendency of prices to reach the wiggle room of equilibrium values that persist for a time while knowledge and preferences do not significantly change.
Imagine if aliens landed the day of the hurricane, and gave everyone a new, seemingly endless and virtually costless energy source that can power any object through wireless charging.
Obviously that would alter the prevailing ERE so much that the price of gasoline would probably collapse to pennies on the gallon, or lower.
Well, the same kind of principle I would say is present in the case of what happened. People’s knowledge and preferences changed somewhat throughout the disaster, while other knowledge and preferences remained the same, and so the prices that prevailed, since Bloomberg and Christie controlled them arbitrarily, could NOT tend towards their equilibrium values at the time.
MF wrote:
I don’t think there is a single ERE.
Now if Sraffa were here, he would say, “Wait a minute MF, earlier in the thread didn’t you say that there’s a tendency for market prices to go to their ERE values, and *this* is what you mean by the ‘natural rate’? So now you’re saying there are multiple EREs. I can only conclude you think the free-market nominal rate of interest should simultaneously be several different numbers.”
I should have said
“There is no unique, unchanging ERE.”
That’s what I meant by no single ERE.
I didn’t mean to imply there are multiple simultaneous EREs.
Also MF it should go without saying that I’m being aggressive on this post and in the comments just to make a strong statement of my position. I think that Mises/Hayek are on to something, and that FRB really does cause an unsustainable boom, but I just don’t like the way Austrians have formulated the position.
Fair enough. Yes, I understood that to be your motivation here all along.
I’ve read your paper on this and I agree with you that if there is more than one natural rate (and I think there are as many natural rates as there are PEOPLE, rather than what Sraffa said which is that there are as many as there are commodities), then theories that assume a single natural interest rate are indeed in need of updating, and I agree that your method does contribute to this.
But that won’t stop me from being as forceful in showing LK what you already accept, which is that the idea that FRB causes booms isn’t going to be refuted by having to add an “s” to the word “rate”.
Having said that, if you or anyone else presented me with an example of a society A whose inhabitants consume everything, and another society B whose inhabitants saved and invested a portion of their incomes, that won’t stop me from knowing that the argument “”The” natural interest rate in society A is higher than “the” natural rate in society B”, while not exactly accurate, still has a coherent meaning for communicative purposes, which both Mises and Hayek had to do given the circumstances of GE being popular at the time.
500 years from now ABCT might have to be framed in a different verbiage once again in order to communicate it to others.
MF wrote:
(and I think there are as many natural rates as there are PEOPLE
That’s really interesting, and it’s what I think when I read stuff like Gene’s post on it. It seems that the way to escape the clutches of Sraffa (and me) is to retreat into subjectivism, in which time preference refers not to anything having to do with units of goods, but with abstract preference or utility. This is OK, if you believe in cardinal utility (so that e.g. time preference of 5% means 100 utils today is the same amount of satisfaction as 105 utils to be experienced in a year), but then there’s no reason for this number to become equalized across people. In equilibrium I could have a subjective time preference factor of 8%, Gene could have 2%, and so on. When the Austrian tries to say, “No, because then there would be an arbitrage…” I think that lets the Sraffa/Murphy objection back in the house.
I don’t think it’s a “retreat” into subjectivism, but rather a realization that the ground for ERE and natural rates was there all along.
I really don’t think it requires cardinal utility.
Suppose in my mind I have a time preference that manifests in no less than me wanting to earn 10% interest on a one year money loan. Key words are “no less”. Does that mean that I would refuse every single possible rate above 10%? Of course not. I would accept any rate above 10%.
This is why I tried to emphasize above that the millions of different natural interest rates in millions of different people’s minds can still manifest in market clearing rates on such things as loans. We just need offsetting natural rates between individuals, where yours is bigger than mine or vice versa, and a willingness (which is connected to the natural rates) and ability to trade.
Same thing happens with goods for money trades. I may sell a hamburger for $10.00, but I am willing to sell it at ANY price above that, if there any takers. But I sell at $10.00 every day because I maximize my profits that way.
My desired market, i.e. a profit maximizing market, tends to clear as long as I am continually searching for profit maximizing selling prices. All those who don’t have offsetting hamburger and $10.00 value scales as compared to me, simply don’t trade with me. They’re not a part of my market.
If I made a mistake, which is likely, then I’ll change my price, but then customer preferences might change too, so it’s a constant tinkering towards an ERE that is never reached.
I don’t think a subjectively grounded natural interest rate requires cardinal utility. My ranked preferences for present and future goods can still be considered ordinal. I prefer one hamburger today over one hamburger tomorrow. In order for you to be able to trade with me given this is true, you would require an ordinal value scale that is offsetting to mine in some way that through trading with me convinces me to delay my hamburger consumption by one day.
Perhaps your value scale is that you rank one hamburger today as less valuable than one carrot today. So you give me a hamburger and I give you a carrot.
For a money loan, you will lend me $10.00 for me to buy a hamburger today only if your desire for present goods as such, i.e. MONEY, is lower than my desire for present goods as such.
You’ll probably consider this a case of liquidity preference being manifested, whereas I would consider it to be a manifestation of our individual natural interest rates, i.e. our individual desires for present goods as such over future goods as such offsetting and allowing for a trade to take place.
Bob Murphy,
Can you please clarify your position on this question:
Consider this quotation of Hayek:
“The primary cause of the appearance of extensive unemployment, however, is a deviation of the actual structure of prices and wages from its equilibrium structure. Remember, please: that is the crucial concept. The point I want to make is that this equilibrium structure of prices is something which we cannot know beforehand because the only way to discover it is to give the market free play; by definition, therefore, the divergence of actual prices from the equilibrium structure is something that can never be statistically measured.” (Hayek 1975: 6–7).
Is Hayek thinking of a convergence to a market- clearing price and wage vector here (that tends to clear all markets, including the labour market)?
That is, is this obviously a type of market- clearing price and wage vector showing the influence of Walrasian GE theory on Hayek?
I’m not trying to dodge the question LK but I’m really not sure. I think this is the subtlety that Hayek bumped up against with Sraffa. I think the idea is that the market could be in “equilibrium” in the sense that prices have stabilized, but not in intertemporal coordination which is “Hayekian equilibrium.” I.e. people think they are optimizing etc. but their forecasts of the future are erroneous, so they are going to have to adjust their plans in an unpleasant way at some point.
Part of what I have been trying to do, is provide Austrians with a richer set of equilibrium constructs, because you can’t distinguish these things if all you care about is “the real world” and “the ERE.”
LK,
Not sure precisely when Hayek wrote the bit you quote but eventually he came around to a view of equilibrium as “plan co-ordination”.
This plan-coordination would be reflected in prices.
So seen that way ” a deviation of the actual structure of prices and wages from its equilibrium structure” would simply reflect a situation where people’s subjective plans are not co-ordinated.
This would be different from a “Walrasian GE theory”.
Oh my gosh… OK Major Freedom so a market economy works so long as prices always tend towards their value in the evenly rotating economy? You think there’s a tendency for oil prices to move towards what their average value will be from the year 2100 – 2400? Or rather, are entrepreneurs trying to whittle away discrepancies and make anticipations about what the price “should” be tomorrow, based on the information relevant tomorrow (which might be obsolete by Friday)?
“…so a market economy works so long as prices always tend towards their value in the evenly rotating economy?”
I would say yes. I remember though that this “evenly rotating economy” is itself constantly changing. So it’s not like there is one unique ERE that we’re all trying to reach like the end of a finish line to a race.
“You think there’s a tendency for oil prices to move towards what their average value will be from the year 2100 – 2400?”
No, because I don’t think that this is the meaning of equilibrium values or proper derivation of the meaning of equilibrium values.
I don’t consider equilibrium values to mean values in some distant arbitrary future. Rather, they are always in the present, constrained to human action, and they are always changing as knowledge and preferences change.
Prices that tend towards their equilibrium values are just prices that are free to fluctuate according to individual property owners who take into account past prices and change current prices to reflect their new knowledge and preferences (new equilibria).
“Or rather, are entrepreneurs trying to whittle away discrepancies and make anticipations about what the price “should” be tomorrow, based on the information relevant tomorrow (which might be obsolete by Friday)?”
It depends on their time horizons. Each individual has their own time horizon, and so the prices that prevail would be those that are tending towards the equilibrium values concomitant with those time horizons. For day traders, I’ll agree. For longer term investors, they care less about what happens tomorrow.
Et tu, Brute?
I’m with ya on this one Bob. Markets need not head toward the asymptotic limit at each moment in order to ‘work’.
“Markets need not head toward the asymptotic limit at each moment in order to ‘work’.”
Depends on what you mean by “each moment.”
If you mean each moment a person considers the value of things in exchanges, before and while they are exchanging, then freely fluctuating prices can be argued as tending towards their equilibrium values “each moment” and that this is needed for markets to work.
Always always always ground your concepts on human action if you are going to be on the same page as me when I use certain terms.
The moment you leave that context, and you start to think of prices, and objects sold for prices, and other such things in terms of contexts abstracted away from human action, like some unstated standard for judging “each moment”, like the single vibration cycle of a cesium atom, or whatever, then you’ve immediately started down a road of confusing what you are reading.
I mean if your imagined asymptotic limit is an ERE with no hurricanes than it’s not the right limit for judging the day after a hurricane. “Oh banana prices went way up, but in the ERE theyd’ be lower, market failure!!!”
So if I don’t define the ERE in terms of any particular content, hurricanes or otherwise, then I would not necessarily be judging with the wrong limit now would I?
The ERE is not concrete bag of particular events, people, preferences, or knowledge, Ken B.
It is an abstract category of thought. A tool. It is used to guide one’s thinking about the real world that is full of concrete events, people, preferences, and knowledge.
Methinks you need to learn what the ERE really is about.
Bala and MF, since I’m agreeing with Ken B. and Lord Keynes on this, believe me, I’m suspicious of my post too…
I think it’s more accurate to say Ken B and LK are agreeing with you. You first made your case, and now they’re saying “I agree with that.”
LK is obviously agreeing with you only because he believes he can then use it as (what he perceives to be) a knock against orthodox Austrianism, and finding faults with orthodox Austrianism that may seem to intellectually lead to anarchism is his actual goal. He just desperately wants a mommy and daddy state, and he’ll point out as many instances of failures in the counter-literature of dotting all the i’s and crossing all the t’s to do it, no matter how esoteric it is (such as multiple natural rates versus single natural rate).
It is sufficient that he can use you for his “Even Murphy agrees with me on this!” purposes, and he’ll hold your water and shine your shoes.
Ken B is agreeing with you because he thinks you think that I and Bala think that prices have to be at or tending towards an ERE or the ERE every nano-second or whatever, in order for markets to “work”, whatever that means.
My understanding is that in orthodox Austrian theory, prices tend towards one ERE at a time, and that the content of any ERE itself changes by virtue of knowledge and preference changes.
The form of the ERE is a mental tool, holding all knowledge and preferences constant, so that the only thing that changes from then on are prices and other nominal variables (arbitrage), after which there is a cessation of even nominal changes.
But assuming people don’t stop learning, and don’t stop changing their knowledge and preferences, any potential ERE in the chain of subsequent EREs, can’t even be hit in principle. But the drive is still there because of a drive for profits and avoidance of losses (nature of human action).
Don’t markets “work” if they move us, under current conditions, towards a pareto improvment? I am not proposing that as a full definition, just that if someone says “ha! your sainted free market is failing!” i think I could refute him if I could show the market was moving us towards a pareto improvement. That would count as “working.”
Now introduce the possibility, nay the inevitability, of people making mistakes, and combined with Pareto improving, you’re basically at the idea of how markets tend towards an ERE.
The only thing that’s really left is to realize that the given set of possible and achievable Pareto improvements are themselves changing.
Bob,
“Bala and MF, since I’m agreeing with Ken B. and Lord Keynes on this, believe me, I’m suspicious of my post too…”
You should be suspicious of your post too and of your own thoughts on this issue given who you side with. Please find my response to your rather funny but aggressive post.
Oops!! I should have said “Please find below”
“the commercial banks IN DAILY PRACTICE ought to set the actual nominal market rate of interest equal to something that would be true in “long-term equilibrium.””
No. In daily practice, commercial banks set the actual nominal market rate of interest, learn from the response of the market and keep tweaking their rates of interest accordingly. I don’t see how this is anything other than the market process of working towards the equilibrium.
I see it has happened in Economics as in most subjects: people write journal papers to be opaque. One of Gene’s virtues, usually, is that he writes well.
Some comments:
1. Sraffa, AFAIK, rejected STV. The PTPT of interest is a purely subjective value theory of interest. AFAIK, the multiple interest rate argument equates quantitative amounts of goods with an interest rate. But that can easily be addressed using PTPT of interest by pointing out interest is due to a qualitative discounting. The debate needs to be shifted to include STV.
2. Interest just isn’t for loans. Why factors of production aren’t bid up so their sum price isn’t equal to the sum of the produced goods rents is explained by the PTPT of interest. Again, it’s because of the qualitative discounting. Also, the relative prices are of importance to understanding investment and business cycles in Austrian theory. Investments aren’t solely funded by loans. Entrepreneurs anticipating a relative price difference is key to understanding.
3. The role of FRB has seemed to be swept aside favoring vague talks of the central bank setting the interest rate. This gives way to much weasel room for the Sraffaians and LKs. FRB doesn’t even need to be addressed by them cause it isn’t brought up or even how a central bank operates.
4. I think there’s some confusion over money being “neutral in the long run”. You can interrupt that as meaning new money does have effects and those effects will be apparent and change the course, so to speak, of the economy compared to if the new money wasn’t added, but the new money will eventually stop causing negative effects. Another interpretation is new money affects the economy but not in a way that effects matter and the long run won’t be any different from the long run of new money not being added. Hayek meant the former. I get the impression the opponents equivocate between the two.
Bob:
“Bala and MF, since I’m agreeing with Ken B. and Lord Keynes on this, believe me, I’m suspicious of my post too”
Welcome to the dark side. We have cookies.
The cookies are also cursed.
Bet you can’t eat just one …
You’re right. I’ll probably get through only half of one before upchucking.
Free Advice, the blog where metaphors go to die.
I will explain why Bob is wrong. More that 8 people have worked through the arithmetic of own-rates. He should name Frank Hahn. Bob might find Hahn’s 1983 article, “The Neo-Ricardians”, in the Cambridge Journal of Economics, of interest. Many Sraffians have answered Hahn, and, thus, also stepped through the calculations.
Glasner misreads Hayek. Hayek’s equilibrium concept in Prices and Production is a long run concept, not a matter of intertemporal equilibrium or plan coordination (even though Hayek had been working on that concept earlier). Hayek’s switches to a notion of intertemporal equilibrium in the midst of his debate with Sraffa. (That’s why he says all those multiple own-rates would be equilibrium rates.)
RV obviously I was joking about the 8 people. After reading your comment, I can’t tell: Are you agreeing with me, or Glasner?
My comment was supposed to be light-hearted, too.
Even though I find Hahn’s article misdirected when it comes to Sraffians, I have no objection to his demonstration of the existence of multiple own-rates in an intertemporal equilibrium. I am agreeing with you.
(Sraffians emphasize Hayek’s importance in changing notions of equilibrium.)
No problem, I wasn’t “snapping” just asking… No body language over the internetz…
“Bala, when Hurricane Sandy hit, Bloomberg and Christie passed rules keeping gas prices at their long-run equilibrium levels. ”
OMG!!! You actually said THIS??? Is it desperation that forces you to do so?
Sandy kicked the total stock curve leftward in the NY/NJ economy. Therefore, given the state of values, technology and resources in the NY/NJ economy and the actual supply of produced goods (particular goods in NY/NJ), the prices shot up. These were indeed the long-run equilibrium prices and NOT an aberration.
What you consider the “long-run equilibrium” prices (the ones Bloomberg and Christie enforced) are actually the prices they thought should operate once the process of production were done and the stock of produced goods in the NY/NJ market reached the level it was at prior to the kicking of the stock curve to the left by Sandy.
“I insisted that entrepreneurs should have the ability to let prices skyrocket upward, temporarily, in light of a fleeting change of circumstances.”
Wait a sec right there!!! This is a perfectly Austrian response. The “fleeting” change of circumstances were not really “fleeting” when then time periods are seen through the eyes of the people whose value scales matter the most – those stranded in the aftermath of Sandy. They needed their “produced goods in NY/NJ” NOW, not after those with the same “things” in other places produced the goods they wanted by transporting them to the NY/NJ market and the process of arbitrage worked itself out and levelled the price across markets. So, it is only Bloomberg’s and Christie’s imposed prices that are real anti-Austrian measures.
“Market prices tend towards what they will be in the ERE?”
Of course they do.
” What would NY and NJ gas prices be in the ERE? Certainly not what people were trying to charge when the hurricane hit.”
Certainly those very prices. That’s because, as I explained, in the short run, we are talking of the NY/NJ market as an ERE by itself. This is simply because the goods we are talking of are not “bread”, “gasoline”, “water”, etc. They are “bread in NY/NJ”, “gasoline in NY/NJ”, “water in NY/NJ”, etc. One can in fact extend it to say “XXX thing where I want it”. What you consider the “long-run equilibrium” price is once a values, technologies and resources change and a new equilibrium in THAT ERE is attained.
So this is why you are wrong in this response and still remain wrong about your original post.
p.s. I know I am being aggressive as well, but then so are you. And sorry about the delay in my response. I live in a different time zone and had gone to bed. Interestingly, I think my aggressive response is still warranted.
OMG!!! Here’s another bloomer, Bob.
“So now you’re saying there are multiple EREs. I can only conclude you think the free-market nominal rate of interest should simultaneously be several different numbers.”
Of course there are multiple ERE’s. It is arbitrage that levels out prices across different ERE”s and keeps transforming the multiple ERE’s into a single ERE again before the next disturbance strikes. What makes you think that all changes in values, attitudes and resources are “global” and not “local”? The first effect of any change in these could reasonably be expected to be in the “local” ERE. This would then set off the process of arbitrage making producers in the “other” ERE respond. However, this process takes some time to work itself out as ALL production takes some time. In the meantime, the 2 markets do work like they were 2 separate ERE’s.
The same holds for interest rate as well. I fail to see what is difficult to understand in this.
p.s. I know this is excessive aggression, but then……
And hence, let me add, it is not your victory but your defeat that is complete!!
p.s. Yet more extreme aggression….
Bob,
Let me summarise the problem in your reasoning as shown in your aggressive response. You are making the fundamental, cardinal error of mistaking “things” for “goods”.
Ken B,
“Markets need not head toward the asymptotic limit at each moment in order to ‘work’.”
Neither I nor MF claimed otherwise before you said this. It is not even necessary for my point to be valid.
“I mean if your imagined asymptotic limit is an ERE with no hurricanes than it’s not the right limit for judging the day after a hurricane.”
Wrong!! It IS the right limit to consider because the goods people want are “particular things NOW”, not the same “particular things in the future”. The supply of produced goods has fallen due to Sandy and therefore, the prices are adjusting. I can see why this is difficult to understand but then you are still wrong.
*not the same “particular things” in the future
To assert that a central planner should set the interest rate equal to the natural rate(s) of interest is just like asserting that a central planner should set the price of bananas at the natural price of fruit.
It presupposes that we should _not_ have a free market in money. That point very much needs to be proven, or it must be rejected out of hand. On its face, it is a ridiculous supposition.
Hayek tied himself in knots by accepting it, and that was his fatal mistake.
And bananas don’t just have a single price either, they can simultaneously sell for different prices at different places around town.
A central bank is like a government store that always offers bananas at one particular price, but only to a select group of fruit merchants.
“Bala, I’m not trying to be a jerk,”
Oh!! I do know that 🙂
“So now we’re trying to talk about what this “natural rate” could be, of which Hayek spoke”
I agree. So there are 2 logically distinct quantities that we are dealing with
1. The money rate of interest that is associated with loans made by banks on a day-to-day basis.
2. The money rate of interest at equilibrium in the ERE for a given structure of time preferences
The former is a an actual figure observable in the markets. The latter is a concept of what the former would be if the market were to work its way towards equilibrium. These are clearly 2 logically distinct quantities.
“You can’t then switch to the money rate and talk about its properties.”
I did not and right there, you failed to understand what I said. The point is that there are 2 money rates of interests – that which is observed and that which would be at equilibrium.
“The point was, Hayek was saying the money rate needed to be equal to some other, logically distinct thing.”
The point that you and LK seem to be missing, as I see it, is that the “natural rate of interest” conceptually manifests itself in the form of the equilibrium money rate of interest which is, as I see it, the 2nd logically distinct category that you claim I am failing to understand.
“You can disagree with where Sraffa/LK/I take that argument, but Hayek himself was saying there was this thing different from the money rate.”
I say that too. As I said above, there is the money rate that exists and the money rate that would exist at equilibrium. Please tell me how these are the same.
“your question above you seem to indicate you don’t get that the “natural rate” is not the same thing as the “money rate” of interest.”
No. On the contrary, your statement shows that you fail to understand my main point – about what the money rate of interest would be at equilibrium for a given configuration of own rates of interests on different commodities.
“If they are always the same thing, then Hayek’s framing of ABCT is nonsensical.”
And as I have shown, they are not the same thing and hence Hayek’s framing of ABCT is NOT nonsensical.
Bob,
Let me put it this way. Are you saying that there would be n different equilibrium money rates of interest each corresponding to one of n different own rates of interest on n different commodities? And if not, then what’s your point?
Here’s another possibility. Are you saying that there are m (>1 but not necessarily equal to n) different rates of the equilibrium money rates of interest that would be in arbitrage free equilibrium with a given configuration of n different natural rates of interest which you define as the own rates of interest on n different commodities? If not, then what else?
*”equilibrium money rate of interest” and not “equilibrium money rates of interest”on line 2. Sorry.
Bala explains nicely exactly how not to think, how not to approach issues, how not to be intellectually honest:
“You should be suspicious of your post too and of your own thoughts on this issue given who you side with.”
Pray how?
Ah!! I get it. I am not working like a scientist, I guess.
I really shouldn’t need to point this out, but I will. You endorse ad hominem and judging arguments by their advocates, not the facts or arguments. That’s what you sentence implies.
No, but I detest it when people throw mud without giving a shred of an explanation as to why the mud was deserved. In all such cases, I see nothing wrong in throwing the mud back.
If you were referring to my earlier observation to Bob, if you couldn’t read that to mean “Given how badly wrong LK clearly is on economics in general and this issue in particular, agreeing with LK means that you are making the same serious mistakes that he is making. So you should be suspicious of your arguments”, I am not to blame.
It is curious how – as opposed to loud mouth know nothings like Bala – the actual academic (non-general equilibrium) Austrian economists like, say, Mario Rizzo freely acknowledge that Post Keynesian economics and Austrian economics have a lot in common, e.g.,
(1) emphasis on Knightian uncertainty
(2) subjective expectations
(4) heterogeneous capital
(5) uselessness of Walrasian GE theory.
If your view of Austrian economics moved beyond Mises and Rothbard, and had some engagement with Lachmann, Rizzo, or O’Driscoll, you’d be considerably less ignorant than you are now.
Too bad you don’t accept subjective expectations and fundamental uncertainty on the part of state regulators and Keynesian policymakers.
Then these concepts go out the window and people suddenly become magical wizards.
Bob,
Here’s another way of putting the same question. For a given configuration of own interest rates on all other commodities taken (as you say) in the form of the ratio of future and spot prices of each commodity, demonstrate that the own rate of interest on the money commodity (just another commodity) could take 2 distinct values, each of which is in arbitrage free equilibrium with every other commodity.
Bob,
First, apologies over posting as Anonymous. I tried posting from my phone for the first time and did not realise that my name and e-mail ID were not there when I clicked on Submit.
Second, apologies again for not being elaborate as I am travelling and have work, but your non-snarky response is clearly wrong. It is conceptually wrong to say “nominal rate” for both the own rate of interest and the rate offered on loans. I will reply ASAP but you will have to bear with me for the delay.
Bala wrote:
It is conceptually wrong to say “nominal rate” for both the own rate of interest and the rate offered on loans. I will reply ASAP but you will have to bear with me for the delay.
OK Bala but just to spare you from having to lecture me (on my dissertation topic): In context, someone had said to me that if we choose the money good as the numeraire, then the problems disappear. So I was saying that with the case of money, the “natural rate of interest” *on the money good* is the same thing as what we generally mean by the nominal rate of interest.
If you think that’s wrong, go ahead and try to prove it, but it will just mean we are using different definitions. That claim is clearly correct, the way I (and Hayek and Sraffa) are using the terminology.
I agree with this post.
@ KenB
“When the price of cheese varies in your money example, then to keep ceteris paribus the price of bread should too shouldn’t it, or the amount of cash you have should. ”
In the barter example then what changes is the cheese/bread barter exchange rate
In the money example then I guess the money price could vary independently for each good (and the desire to hold money balances would adjust to take the slack if this is a 2-good plus money model as you suggest).
I don’t think this changes much in the analysis.
https://smilingdavesblog.wordpress.com/2014/10/04/saving-ae-from-piero-sraffa/