14 Jul 2011

Murray Rothbard, Muddled Thinker, and Accountants are All Keynesians Now

Financial Economics 12 Comments

[UPDATE below…]

I realize this is inside baseball and maybe 95% of you don’t care, but I have real work to do so this occupies my attention…

Major Freedom has been doing his best to escape from the power of my simple point that savings is income minus consumption. He claims that this is a muddled statement because the units don’t even match; he claims income is a flow concept while consumption is a stock concept.

Because I dug up Mises explicitly saying that savings is production minus consumption, MF was forced into saying that production is also a stock concept. (Otherwise Mises would be as muddled as Murphy.) So I asked him what happens when someone produces something and earns an income on it? I’m waiting to hear how we wriggle out of that. (I.e. you would have to earn an income over a time period, even though production is allegedly a stock concept.)

Also relevant, here is Murray Rothbard on pages 419-420 of Man, Economy, and State:

It is clear that the gross savings that maintain the production structure are the “productive” savings, i.e., those that go into productive investment, and that these exclude the “consumption” savings that go into consumer lending. From the point of view of the production system, we may regard borrowing by a consumer as dissaving, for this is the amount by which a person’s consumption expenditures exceed his income, as contrasted to savings, the amount by which a person’s income exceeds his consumption.

If I didn’t know any better, I would say that Rothbard is endorsing my claim that over a defined time interval, savings = income – consumption. But Rothbard can’t be as muddled as me, so I must be wrong.

Also, in accounting the income statement is certainly a flow concept. You don’t say, “What’s your income statement for July 6, 2011, at 4:55pm?” Rather, you say, “What’s your income statement for the 3rd quarter of 2011?”

And yet, if my eyes don’t deceive me, the income statement calculates net income by looking at gross revenues and subtracting various expenses that were incurred during the period in question. It almost sounds like spending is a flow concept. More muddled, Keynesian thinking.

(To drop the cuteness: Major Freedom is focusing on the fact that when you consume, you spend money in bursts to buy consumption goods. Right, but by the same token, when you earn income, you receive money in bursts. Yet even Major Freedom admits that income is a flow concept, defined over a period of time. In contrast, your cash balance or your inventory of physical capital goods is a stock concept–it is defined for a particular moment in time.)

UPDATE: I am not doing any more posts on this, I promise. (Unless Paul Krugman links me or something.) One last point to illustrate how hopeless Major Freedom’s position is: Remember, he had to say that production is a stock concept, in order to reconcile his claim that consumption is a stock concept with Mises’ quotation saying savings is production minus consumption.

So look at how tangled that move makes us: I would say, “In a free market, workers get paid according to their marginal product.” MF agrees, I take it. And yet, workers pay (income or wage rate) is clearly a flow concept. So how can they be paid according to marginal product, unless marginal product is also a flow concept?

Another example. I bump into Henry Ford and ask him, “How much production does your factory yield?” He says, “100 cars.” Does anyone see why his answer is ambiguous?

In contrast, if I say, “How many drill presses does your factory have?” and he says, “100,” there is no ambiguity at all.

Does everyone see why? (Everyone except Major Freedom, I mean.)

12 Responses to “Murray Rothbard, Muddled Thinker, and Accountants are All Keynesians Now”

  1. jjoxman says:

    It is painfully obvious that saving and consumption are both continuous variables that get discussed in discrete terms. We get a lump of a paycheck, we pay for a lump of groceries, etc. Whatever I don’t consume is, of necessity, saved.

    What is important vis-a-vis the discussion of the market rate of interest (btw, there isn’t just one) is how I hold my savings (note the plural). In other words, I, as a household, have a “capital structure” if you will. I hold some in checking, savings accounts, mutual funds, equity securities, etc. Part of this is demand for liquidity, as Keynes called it. I wager most people think of it in terms of risk management – you don’t want to have to sell nice equities all of a sudden to repair your dryer, for example.

    But in my view, the demand for liquidity can only tell us part of the story. It can tell us why people hold a minimum balance in the checking account, for example, rather than lending in CDs. The other factor is time preference in the sense of planning for the future. This tells us about the capital structure of a household.

    To fix ideas, think of owning mutual funds. These are very liquid vehicles in the sense that I can hold a mutual fund and get my money bank with minimal expected discount very quickly – by end of business usually. On the other hand, I want to hold them for a long time to get the capital growth. So liquid on one hand and long time frame on the other. A perfect example? No – but I think it gets to the idea appropriately.

    What I’m ultimately saying is that any construct known as the “market rate of interest” will combine both liquidity and time preference.

  2. Patch says:

    Perhaps this is me trying to read between the lines a little bit, but I was of the impression that Rothbard thought savings=investment.

    In Chapter 6, where Rothbard starts talking about the production structure, the interest rate, and savings, Rothbard explicitly states that “Problems of hoarding and dishoarding from the cash balance will be treated in chapter 11 on money and are prescinded from the present analysis” (page 398). If one takes this statement strongly that all matters related to hoarding are abstracted from, your quote on page 420 is still in agreement with the statement that savings cannot be hoarded. Since in Rothbard’s framework, any Income-consumption in the ERE is invested in the production structure and not hoarded, then in the ERE savings can be defined as Income-consumption, since it necessarily equals investment.

    Rothbard writes clearer of his opinion that savings=investment in America’s Great Depression. Starting in Chapter 2:

    There are two standard Keynesian criticisms of the Mises cycle theory. One charge takes the followers of Mises to task for identifying saving and investment. Saving and investment, the Keynesians charge, are two entirely separate processes, performed by two sets of people with little or no link between them; the “classical” identification of saving and investment is therefore illegitimate. Savings “leak” out of the consumption-spending stream; investments pour in from some other phase
    of spending. The task of government in a depression, according to the Keynesians, is accordingly to stimulate investments and discourage savings, so that total spendings increase.

    Savings and investment are indissolubly linked. It is impossible to encourage one and discourage the other. Aside from bank credit, investments can come from no other source than savings (and we have seen what happens when investments are financed by bank credit). Not only consumers save directly, but also consumers in their capacity as independent businessmen or as owners of corporations. But can’t savings be “hoarded”? This, however, is an artificial and misleading way of putting the matter. Consider a man’s possible allocation of his monetary assets:

    He can (1) spend money on consumption; (2) spend on investment; (3) add to cash balance or subtract from previous cash balance. This is the sum of his alternatives. The Keynesians assume, most contrivedly, that he first decides how much to consume or not, calling this “not-consumption” saving, and then decides how much to invest and how much to “leak” into hoards. (This, of course, is neo-Keynesianism rather than pure Keynesian orthodoxy, which banishes hoarding from the living room, while readmitting it by the back door.) This is a highly artificial approach and confirms Sir Dennis Robertson’s charge that the Keynesians are incapable of “visualizing more than two margins at once.”2 Clearly, our individual decides at one and the same stroke about allocating, his income in the three different channels. Furthermore, he allocates between the various categories on the basis of two embracing utilities: his time preferences decide his allocation between consumption and investment (between spending on present vs. future consumption); his utility of money decides how much he will keep in his cash balance. In order to invest resources in the future, he must restrict his consumption and save funds. This restricting is his savings, and so saving and investment are always equivalent. The two terms may be used almost interchangeably.

    These various individual valuations sum up to social time-preference ratios and social demand for money. If people’s demand for cash balances increases, we do not call this “savings leaking into hoards”; we simply say that demand for money has increased. In the aggregate, total cash balances can only rise to the extent that the total supply of money rises, since the two are identical. But real cash balances can increase through a rise in the value of the dollar. If the value of the dollar is permitted to rise (prices are permitted to fall) without hindrance, no dislocations will be caused by this increased demand, and depressions will not be aggravated. The Keynesian doctrine artificially assumes that any increase (or decrease) in hoards will be matched by a corresponding fall (or rise) in invested funds. But this is not correct. The demand for money is completely unrelated to the time-preference proportions people might adopt; increased hoarding, therefore, could just as easily come out of reduced consumption as out of reduced investment. In short, the savings-investment–consumption proportions are determined by time preferences of individuals; the spending-cash balance proportion is determined by their demands for money.

    My quote is a little long, but I think it summarizes Rothbard’s view on saving/hoarding quite well. His sentence “This restricting is his savings, and so saving and investment are always equivalent. The two terms may be used almost interchangeably” is pretty clear cut in showing his assertion that savings cannot be hoarded. Rothbard would have made a serious error in writing this yet believing something else.

  3. Bob Roddis says:

    “Lord Keynes” has linked to you. I suppose that doesn’t count (for much).

    http://socialdemocracy21stcentury.blogspot.com/2011/07/robert-p-murphy-on-pure-time-preference.html

  4. multipledrafts says:

    “I am not doing any more posts on this, I promise.”

    Could you at least do one more post about this, explaining why you don’t think accepting a liquidity preference theory of interest entails Keynesian policy prescriptions? It seems to me there’s a direct path from liquidity preference, to Hicks’ ISLM, to Krugman’s 1998 and 2011 liquidity trap models. Obviously as an Austrian you believe in the significance of heterogeneous capital and the temporal structure of production, but still, shouldn’t you end up at some weird Austrian/Keynesian synthesis, rather than accepting the traditional ABCT?

    • bobmurphy says:

      For one thing, I don’t see how a liquidity preference theory of interest leads to unemployment equilibrium. I still think real wages fall and clear the labor market.

      • Keshav Srinivasan says:

        Do you dispute Krugman’s constant assertions that there is a nominal wage rigidity?

  5. Major_Freedom says:

    So I asked him what happens when someone produces something and earns an income on it? I’m waiting to hear how we wriggle out of that. (I.e. you would have to earn an income over a time period, even though production is allegedly a stock concept.)

    I answered here:

    http://consultingbyrpm.com/blog/2011/07/murphy-kuehn-tag-team-on-wenzel.html#comment-20417

    “Only if his costs (prior money expenditures made in the past) are less than his current revenues. If his costs are more than his revenues, then he doesn’t earn an income. He incurs a loss.”

    You also said:

    “MF, yes if you earn $20 from cutting my grass, and don’t spend the money on consumption, then you are saving the $20 during the interval of non-consumption.”

    I then asked:

    “If that is the case, then is there any way for people to NOT save out of their income, if a positive amount of time necessarily exists between the time they earn money and the time they spend it?”

    I’m still waiting on an answer for that.

    No doubt you probably agree that it is impossible for people to not save. Assuming you will agree to that, then you would have to agree that this would make Johnny a saver even if he spends all $20 each week. In fact, he would be a saver no matter how fast he consumes out of his income. As long as one microsecond of time passes, he’s a saver. Indeed, every single person on Earth who owns any cash balance whatever would have to be called a saver and said to be engaging in savings. But then all you would be saying is that money is valued such that people hold onto sums of money for a definite time frame.

    If you say Johnny saves for no more than a year, then I say he is not saving out of his yearly income.

    If you say Johnny saves for no more than a week, then I say he is not saving out of his weekly income.

    And so on.

    I can see no meaning to the word “saving” in the way you are treating it other than you saying that people value money in such a way that they hold onto it for a positive length of time, which of course means always if money is going to even function as a money!

    Sure, if you define saving as “holding onto cash for a period of time”, which you did in your Johnny example, then yes, Johnny is saving. He would be saving because it is physically impossible for him to not take ownership of the $20 for anything other than a positive period of time. You are saving, I am saving, we’re all saving! Nobody is not saving. Everyone would be saving all the time if they hold any cash at all. You might as well just say “saving = existence of money.” Why go out of your way to say that people are saving over time, if everyone saves as long as money exists? It’s not saying anything other than “holding cash.” This is why “saving” is a pretty sloppy way to describe cash hoarding. Yes, I know Mises and Rothbard both called this process saving, but they, contrary to Keynes, held this kind of saving as SEPARATE from saving in the form of investment in capital. Keynes treated hoarding and investment as the same thing. His usage of the term saving meant two different things as if they were one.

    And yet, if my eyes don’t deceive me, the income statement calculates net income by looking at gross revenues and subtracting various expenses that were incurred during the period in question. It almost sounds like spending is a flow concept. More muddled, Keynesian thinking.

    I don’t see what the problem is here to be honest.

    Income is flow, because it compares (say, yearly) revenues to (say, yearly) expenses over a time period.

    Consumption spending is stock, because it is just the act of spending not for the purposes of making subsequent sales. Sure, you can look at consumption events over time, just like you can look at cash balances over time. But so what.

    Investment is flow, because it is spending for the purpose of making subsequent sales.

    (To drop the cuteness: Major Freedom is focusing on the fact that when you consume, you spend money in bursts to buy consumption goods. Right, but by the same token, when you earn income, you receive money in bursts. Yet even Major Freedom admits that income is a flow concept, defined over a period of time. In contrast, your cash balance or your inventory of physical capital goods is a stock concept–it is defined for a particular moment in time.)

    Your sales receipts are in bursts. Your income is not just a given sales receipt burst. It is specifically how many such sales receipt bursts you received over a given definite time period, which is a flow concept, minus the prior costs you incurred, which are a function of prior investments, which are spending for the purposes of making subsequent sales, which is also flow. The units match and are commensurable.

    One last point to illustrate how hopeless Major Freedom’s position is: Remember, he had to say that production is a stock concept, in order to reconcile his claim that consumption is a stock concept with Mises’ quotation saying savings is production minus consumption.

    For the record, I’m not actually trying to defend Mises in order to defend my own position. If my position is contra Mises, then so be it, but that doesn’t mean your position is necessarily right. But hopeless? Mirror mirror on the wall…

    So look at how tangled that move makes us: I would say, “In a free market, workers get paid according to their marginal product.” MF agrees, I take it. And yet, workers pay (income or wage rate) is clearly a flow concept. So how can they be paid according to marginal product, unless marginal product is also a flow concept?

    This might be somewhat frustrating for you to hear this, but I actually don’t agree with Rothbard’s MUDDLED notion that workers get paid their marginal revenue product. Rothbard held that a worker’s wages are determined by the marginal revenue product of their labor. This notion presumes that it is possible to attribute a physical product to each factor of production for every single case, and then take the monetary value of that physical product and call it the marginal value product.

    This works in principle so long as the context is the very narrow one of agriculture, which is what Rothbard always used, because here what typically happens is that land will be used to the point where diminishing returns sets in, and that usually enables one to see what would happen if one worker was removed, and the resulting production is considered. For example, if 10 workers produce 1,000 bags of grain, while 9 workers produce 910 bags of grain on the same land, then Rothbard would say that the 10th worker is responsible for 90 bags of grain. 90 bags of grain are the marginal product of labor on this land. The marginal value product is the marginal product of 90 bags of grain multiplied by the price of a bag of grain. If the price of a bag is $10, then the marginal value product is $900. Thus the wages for each worker would supposedly be $900. If the supply of such labor were smaller, then the wages of those workers would be greater. If it were greater, the wages of those workers would be smaller. For 10 workers then, they get paid $9,000, and the total revenues for the 1,000 bags will be $10,000.

    I don’t agree with this conception. Why? Well, what if removing a single worker, from 10 to 9, leads to grain production dropping by 110 bags? We can imagine this worker being a specialist of some sort, maybe he is the only one who knows how to operate a complex machine, or whatever.

    What will be the marginal product? It will be 110 bags of grain. If each of the 10 workers is to be paid in accordance with marginal productivity, then the total wages paid would be greater than the value of the products produced. They would be 10 times 110, or 1100, times the price of the product. Nothing would be left for profit, or even to allow for the value of other factors of production.

    Rothbard always used examples where the marginal product of a removed worker, divided by the total production, is less than the percentage that worker represents out of the total number of workers. But this is not always the case.

    Just imagine a small car company where a single worker, out of 10, who is in charge of putting the brakes on each car, was removed from the production process. What will be the value of the resulting product? Virtually nil. Thus his marginal value product is identical, or close to, the value of the whole car. The same principle would hold for the other workers. The total marginal-value product for these workers would be multiples of times greater than the value of the output, an economic impossibility.

    So much for marginal product of labor.

    As for your question “how can they be paid according to marginal product, unless marginal product is also a flow concept?” my answer is that because I hold marginal value product to be dubious, if not completely wrong, to even ask me what kind of a concept it is would make my answer meaningless because I don’t even hold it to be true.

    If I had to guess on what it is, my guess would be that it is a flow concept, because paying a worker a wage is an investment for the purposes of making subsequent sales, and investment is a flow concept.

    Another example. I bump into Henry Ford and ask him, “How much production does your factory yield?” He says, “100 cars.” Does anyone see why his answer is ambiguous?

    You snuck in the word “yield” which turns the otherwise stock concept of production, into a flow concept. His answer is ambiguous because you asked him a flow question and he responded with answer that makes no distinction.

    If you had instead asked him “How many produced cars do you have in your warehouse?” He would say “100.” That would not be ambiguous. If you then asked him “How many cars are sold?” He would say “80.”

    The next moment in time (next hour, next day, next week, etc) you can ask him the same questions.

    If you define production as how many cars are produced over a given time period, then it is flow. If you define consumption as how many goods bought over a given time period, then it is flow.

    But production and consumption are, the way I defined them, stock concepts. To produce a car is to create a produced car. Sure, it will take time to do it, just like it takes time to eat a sandwich. But the selling of cars, and the buying of cars, those are stock concepts. Any income earned on selling cars, that’s flow, because income is total money receipts over a given time period. The buying and selling of cars is not (well, unless someone bought a car for the purpose of making subsequent sales, which makes the car an investment, which makes it a flow concept).

    In contrast, if I say, “How many drill presses does your factory have?” and he says, “100,” there is no ambiguity at all.

    Indeed.

    OK, I can see where this is going. You’re trying to argue that because my definitions are way different that yours, and different from mainstream economics textbooks, you equate the painful and slow discovery of my definitions (my fault, not yours, I am not doing a very good job here) as me retreating and mangling and desperately trying to find an escape route. I’m sorry if you feel that way but I have held the same positions the entire time.

    I have yet to see you answer the myriad of criticisms I laid out regarding your adherence to the liquidity preference theory of interest. I see you going off the rails on all kinds of semantic type arguments, but you are not answering the crucial points I made. To recap those criticisms, and hopefully you will answer them this time, they are:

    1. Under very rapid inflation, liquidity preference drops to virtually zero, and yet interest rates skyrocket to very high levels. Similarly, when inflation is more modest, liquidity preference rises, and yet interest rates are much lower. This is directly contrary to what the liquidity preference theory of interest claims should happen.

    2. If it is “parting with liquidity” that generates interest, then why don’t people earn interest for “parting with liquidity” when buying consumer goods, or giving to charity? Why do only INVESTMENTS earn interest specifically?

    3. Why do you assume that time preference has to be linear, such that it fails to account for an upward sloping yield curve, thus vindicating Keynes and refuting the Austrians? Why does waiting 10x longer than 1 year have to earn 10x the interest annualized? Why can’t a 10 year bond earn more annualized interest relative to the 1 year on account of people’s time preference not being linear, but exponential? Think about it. It’s easy to wait one minute to abstain from eating if you just ate. But does that mean that abstaining from eating for 1 month should be a linear function of the “sandwich preference” for that initial one minute, multiplied by however many minutes there are in 1 month? Absolutely not! The longer the time that goes by, the more intense will time preference be felt. At some point, waiting another minute for food will be so intense and so important that one would probably give their kidney, their left arm, and their life savings, if it meant they could eat at some point in that next minute. But the initial first minute was very easy to abstain from eating.

    • bobmurphy says:

      MF wrote:

      Consumption spending is stock, because it is just the act of spending not for the purposes of making subsequent sales. Sure, you can look at consumption events over time, just like you can look at cash balances over time. But so what.

      Investment is flow, because it is spending for the purpose of making subsequent sales.

      So if I spend $1 on sunflower seeds and eat them, that spending was a stock event. If I spend $1 on sunflower seeds and bury them in the ground, hoping that down the road a sunflower plant will grow, then it is a flow over a period of time? Are you saying investment expenditures are a flow, because they have a forward-looking time frame involved? If so, when someone says, “How much did your firm invest last year?” you think that means, which of their investment decisions were only 12 months in duration? Or do you instead think it means, “How much money did you spend on investments, over the course of a year?”

      • Major_Freedom says:

        Why won’t you answer the 3 criticisms of liquidity preference, and instead choose to declare victory over a typo?!

        So if I spend $1 on sunflower seeds and eat them, that spending was a stock event. If I spend $1 on sunflower seeds and bury them in the ground, hoping that down the road a sunflower plant will grow, then it is a flow over a period of time?

        Yes.

        Are you saying investment expenditures are a flow, because they have a forward-looking time frame involved?

        Because it has a multiple cash flow implication over time.

        If so, when someone says, “How much did your firm invest last year?” you think that means, which of their investment decisions were only 12 months in duration? Or do you instead think it means, “How much money did you spend on investments, over the course of a year?”

        How many forward looking investments made over the course of a 12 month period. That’s why you see assets of varying maturities.

        Please answer the three criticisms!

      • Major_Freedom says:

        Are you saying investment expenditures are a flow, because they have a forward-looking time frame involved?

        Or just cash flow per unit of time.

  6. Chris Pacia says:

    Are you still going to publish the article on Rothbard’s view of yield curve tomorrow? I’m interest in your opinion. Also, what do you make of the idea advanced by austrians that the yield curve is upward sloping only because of fed manipulation of short term rates? If true wouldn’t that hurt the liquidity preference theory?

  7. Bala says:

    I’m going to try defending Major_Freedom but from my own angle. You said

    “Major Freedom has been doing his best to escape from the power of my simple point that savings is income minus consumption.”

    I think your simple point may be incorrect in the first place. A better way to put it is

    Income – Consumption = Addition to cash balances

    IMHO, addition to cash balances should not be considered savings as there is no forsaking of a present good for a future good. There is only an exchange of one present good (the consumers’ goods that could be obtained with a certain amount of money) for another present good (the cash itself). It is only cash holding that is exchanged for future goods that should ideally be called savings.

    Strike me dead if I am wrong, but this is what strikes me.