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Tuesday, June 21, 2011

Mises’s “Originary Interest Rate” Theory

Mises uses the Wicksellian natural interest rate in his earlier work on Austrian business cycle theory. But, by the time of Human Action (1949), Mises is employing an “originary interest rate” concept, and talk of the natural rate largely disappears. Mises explains the theory:
“Originary interest is the ratio of the value assigned to want-satisfaction in the immediate future and the value assigned to want-satisfaction in remote periods of the future. It manifests itself in the market economy in the discount of future goods as against present goods. It is a ratio of commodity prices, not a price in itself. There prevails a tendency toward the equalization of this ratio for all commodities. In the imaginary construction of the evenly rotating economy the rate of originary interest is the same for all commodities” (Mises 1998: 523).
This means that the originary interest is a future discounted good exchanging for a present good of higher value.

In terms of capital goods, this presumably means the discounted value of future goods against present goods that are borrowed now for capital goods investment.

But this is really just another real theory of the interest rate where loans are imagined as occurring in natura, or in real commodities in an economy at full employment. Mises is still subject to Sraffa’s critique of Hayek.

Curiosuly, when we turn to Roger Garrison we find the explicit use of the Wicksellian natural rate, as in Hayek’s work:
“So named by Swedish economist Knut Wicksell, the natural rate of interest is the rate that reflects the underlying real factors. In macroeconomic terms as applied to a wholly private economy, it is the rate that governs the allocation of resources between current consumption and investment for the future. By keeping saving and investment in balance, the natural rate guides the economy along a sustainable growth path. That is, governed by the natural rate, unconsumed current output (real saving) is used for augmenting the economy’s productive capacity in ways that are consistent with people’s willingness to postpone consumption. In the hands of the Austrian economists, the natural rate became the rate that reflects the time preferences of market participants and allocates resources among the temporally defined stages of production. The output of one stage serves as input to the next in this logical and broadly descriptive representation of the economy’s production process. The temporal dimension of the economy's capital structure is a key macroeconomic variable in Austrian theory. .... In summary terms, the natural rate is seen as an equilibrating rate. It is the rate that tells the truth about the availability of resources for meeting present and future consumer demands, allowing production plans to be kept in line with the preferred pattern of consumption. By implication, an unnatural, or artificial, rate of interest is a rate that reflects some extra-market influence and that creates a disconnection between intertemporal consumption preferences and intertemporal production plans” (Garrison 2006: 58–59).
So Garrison is also subject to same critique as Hayek. Yet in Garrison’s book Time and Money: The Macroeconomics of Capital Structure (London and New York, 2000), the word “Sraffa” does not (as far as I can see) even appear. It’s as if the Hayek–Sraffa exchange never occurred.


BIBLIOGRAPHY

Garrison, R. W. 2000. Time and Money: The Macroeconomics of Capital Structure, Routledge, London and New York.

Garrison, R. W. 2006. “Natural and Neutral Rates of Interest in Theory and Policy Formulation,” Quarterly Journal of Austrian Economics 9.4: 57–68.

Garrison, Roger W. 2007. “Natural and Neutral Rates of Interest in Theory and Policy Formulation,” Mises Daily, April 21
http://mises.org/daily/2513


Mises, L. 1998. Human Action: A Treatise on Economics, Mises Institute, Auburn, Ala.

31 comments:

  1. I think it's quite possible to create an abstraction and say that a "natural rate" does really exists, which would equate savings with investment and is in accordance with the structure of production and time preference of the market participants, as Knut Wicksell seemed to say. What is left for the Austrians to explain is how the market approaches that "natural rate" in reality.

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  2. Ivanfoofoo,

    Of course, it is possible to construct an imaginary world where the "natural rate" does exist. The point is: the Austrians can't explain how it works in the real world.

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  3. "The point is: the Austrians can't explain how it works in the real world."

    How do you explain it to someone who says there are no real world equilibriating mechanisms ignoring the concept of arbitrage????

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  4. "Of course, it is possible to construct an imaginary world where the "natural rate" does exist."

    Good. That's a step forward. I see that you are capable of learning.

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  5. I found this interesting read about F.A Hayek (and von Mises) at reality.gn.apc.org/econ/hayek.htm
    It is named : Information and Economics:
    A Critique of Hayek by Allin F. Cottrell and W. Paul Cockshott

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  6. How do you explain it to someone who says there are no real world equilibriating mechanisms ignoring the concept of arbitrage?

    I don't deny the existence of arbitrage - but arbitrage alone isn't sufficient to cause the self-equilibriating markets imagined by both Austrians and neoclassicals. Subjective expectations and uncertainty destroysany postulated mechanism that equates investment demand with loanable funds supply.

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  7. " but arbitrage alone isn't sufficient to cause the self-equilibriating markets imagined by both Austrians and neoclassicals. "

    Of course it isn't. There is the 'profit and loss mechanism' by which capital moves from the hands of those whose actions in the face of subjective expectations and uncertainty are poor (i.e., the incompetent entrepreneurs/capitalists) to the hands of those whose actions in the face of subjective expectations and uncertainty are good (i.e., the competent entrepreneurs). In the words of Bob Roddis, those who make bad decisions get a smack in the face while those who make good decisions get rewarded. To make it simpler, no one can keep making mistakes because they would soon run out of capital to play with.

    Anyone who says that there aren't self-equilibriating forces in the real world is a fool and an ignoramus who doesn't understand what the combination of arbitrage and the profit-loss mechanism do.

    "Subjective expectations and uncertainty destroysany postulated mechanism that equates investment demand with loanable funds supply."

    Nonsense. It is credit expansion backed by interest rate depression and monetary inflation that destroys the mechanism that equates investment demand with loanable funds supply.

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  8. "It is credit expansion backed by interest rate depression and monetary inflation that destroys the mechanism that equates investment demand with loanable funds supply."

    Even a 100% reserve banking system won't overcome the problem of subjective expectations and the instability of investment. You cannot eliminate uncertainty.

    Since a 100% reserve banking system has never existed in the real world, you also have no empirical evidence to support your assertion.

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  9. "Even a 100% reserve banking system won't overcome the problem of subjective expectations and the instability of investment. You cannot eliminate uncertainty."

    This is an nonsensical as it gets. That is where the 'profit-loss mechanism' steps in. Bad lenders lose their capital. It goes into the hands of good bankers (because they are the ones who will survive the weeding out process of the 'profit-loss mechanism').

    Further, uncertainty is a category of human action. It is individual human actors that face uncertainty. And once again, it is the 'profit-loss mechanism' that handles uncertainty. Those who handle uncertainty better survive while those who handle it poorly, cease to be capitalists and join the ranks of labour.

    Finally, it is idiotic to say that investment is subject to instability. That is as foolish as it gets. I wouldn't disagree that investment is subject to uncertainty, but when you say 'instability' you are assuming the conclusions you want to prove. Even this uncertainty in investment is handled by the 'profit-loss mechanism'.

    "Since a 100% reserve banking system has never existed in the real world, you also have no empirical evidence to support your assertion."

    Meaningless assertion in the context of the discussion.

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  10. Bala, you should be more familiar with Post-Keynesianism. I share your admiration to the Austrian School (or at least, some part of it), but after reading your following statements:

    "Of course it isn't. There is the 'profit and loss mechanism' by which capital moves from the hands of those whose actions in the face of subjective expectations and uncertainty are poor (i.e., the incompetent entrepreneurs/capitalists) to the hands of those whose actions in the face of subjective expectations and uncertainty are good (i.e., the competent entrepreneurs)."

    And:

    "This is an nonsensical as it gets. That is where the 'profit-loss mechanism' steps in. Bad lenders lose their capital. It goes into the hands of good bankers (because they are the ones who will survive the weeding out process of the 'profit-loss mechanism').

    Further, uncertainty is a category of human action. It is individual human actors that face uncertainty. And once again, it is the 'profit-loss mechanism' that handles uncertainty. Those who handle uncertainty better survive while those who handle it poorly, cease to be capitalists and join the ranks of labour."

    Both presuppose the concept of "epistemological uncertainty". But Post-Keynesianism support the concept of "onthological uncertainty". There is no process that can handle that, because that uncertainty lives in the nature of things, and not just in the impossibility for a single human to handle it. For (most) Austrians, the market is the "deus-ex machina" that brings all plans into coordination, but that proposition requires a leap of faith to be held.

    Every economist on earth acknowledges that there are lots and strong equilibrating processes in the market (take for example the price system in spot markets, where speculation is mostly absent and future markets (uncertainty) is minimal as well). But here the key words are "future" and "uncertainty". When time enters into the equation, subjective considerations about future market values enter into the picture also, and that generates disequilibrating processes as well. We just can't know which of both forces will outperform the other one ex-ante.

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  11. "Finally, it is idiotic to say that investment is subject to instability. That is as foolish as it gets. I wouldn't disagree that investment is subject to uncertainty, but when you say 'instability' you are assuming the conclusions you want to prove."

    Replace "instability" for "stability". What's the difference?

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  12. "Replace "instability" for "stability". What's the difference?"

    A lot. One is a war-cry for interventionism and the other is a clarion call for a 'keep your grubby hands off' policy.

    "But Post-Keynesianism support the concept of "onthological uncertainty""

    If it does (on which point I take your statement at face value), then it ignores the fundamental point that action faces all forms of uncertainty, epistemological and ontological. Whatever combination of uncertainties an entrepreneurial action faces, the mechanisms of the real-world market (which include arbitrage and the 'profit-loss mechanism') ensure that successful forecasters are rewarded while unsuccessful ones are relieved of their capital and thus their role as entrepreneurs.

    So, your point about which of the forces will predominate appears quite misplaced to me.

    Further, it is incorrect to state that Austrians see the market as a 'deus-ex-machina'. The market is just all the humans acting to relieve their uneasiness and to make their future conditions better than they would be in the absence of their action. Austrians just state that there are sufficient market forces in the real world that tend to coordinate the actions of all these apparently uncoordinated planners and bring about an order that allows every individual to attain the highest position on his or her value scale for on a free market without violent intervention, all actions would be voluntary.

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  13. You cannot overcome ontological uncertainty merely by profit and loss or arbitrage.

    Moreover, your analysis is ridiculously flawed: it assumes the other major "mechanism" whereby markets allegedly lead to co-ordination: Say's law, a total myth.

    "Austrians just state that there are sufficient market forces in the real world that tend to coordinate the actions of all these apparently uncoordinated planners and bring about an order that allows every individual to attain the highest position on his or her value scale for on a free market without violent intervention, all actions would be voluntary. "

    That is false: "Austrians" are divided on the issue of whether markets lead to plan/pattern coordination.
    Don't waste our time pretending that issue commands some kind of consensus amongst Austrians: it doesn't. It deeply divides them.

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  14. "You cannot overcome ontological uncertainty merely by profit and loss or arbitrage."

    Total nonsense. It is not about 'overcoming' uncertainty. First get over that puerile fascination. It is about action in the face of uncertainty. Those who forecast well are rewarded and those who do so poorly are penalised. For acting man, it hardly matters whether the uncertainty it epistemological or ontological. He faces the consequences of his actions all the same.

    "Say's law, a total myth"

    Rubbish. Only in warped whatever-Keynesian half-brains (there isn't any other type of whatever-Keynesian).

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  15. I repeat: "Austrians" are divided on the issue of whether markets lead to plan/pattern coordination. I notice you dropped that line of argument. One branch would agree with me, one with you.

    Also, I notice, you haven't even demonstrated that mechanisms exist to equate credit demand with savings in loanable funds. Another myth.

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  16. "Also, I notice, you haven't even demonstrated that mechanisms exist to equate credit demand with savings in loanable funds. Another myth."

    ROFLMAO. It's a myth because the great Lord Keynes has pronounced it to be. It doesn't matter that at higher interest rates, the demand for credit would fall while at lower interest rates, the demand for credit would rise. It doesn't matter that if interest rates were below the natural rate of interest (which is a product of the time preference schedules of all the human actors who constitute the market), arbitrage opportunities are created between the loanable funds market and the myriad lines of production where interest return to pure capitalists are higher (inline with the natural rate of interest). No. People would not rush in to capitalise on this opportunity and would instead sit on the sidelines twiddling their thumbs.

    Yeah!! Once again, there is no such thing as arbitrage. People are too dumb not to buy present goods on the lower priced loanable funds market and sell them in the higher priced producers' and consumers' goods producers' markets and get arbitrage profits.

    And lenders would be under no pressure to raise their interest rates in response to the mismatch between demand and supply of loanable funds.

    Yup. There are no mechanisms to equate demand for credit and supply of loanable funds. What goop!!!

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  17. "One branch would agree with me, one with you."

    Which 'branch' with you and which with me?

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  18. On the matter of the existence of plan/pattern coordination imagined by Hayek, the Lachmann radical subjectivists would agree with me.

    The moderate subjectivists like Kirzner would agree with you.

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  19. at lower interest rates, the demand for credit would rise.

    Not necessarily true, because of uncertainty and shifting business expectations.

    And this is PRECISELY why the Austrian school is itself split on the subject.

    And, curiously, it is here that the Lachmann wing and Post Keynesians converge on this issue:

    “The natural extension of the subjectivist concept from preferences to expectations implies that [sc. Lachmann’s and the radical subjectivists’s] Austrian views on human action and market processes and Keynesian theory on the instability of investment are complementary. Within the Keynesian understanding Shackle did much to ensure consistency and clarity in the Keynesian understanding of the role of subjective expectations. Lachmann did the same for Austrian economics. Because both Lachmann and Shackle were open to the views of subjectivists from other schools, the result is a large measure of similarity in (some) Austrian and post-Keynesian theories on the role of expectations. The similarity is such that Lachmann (1978: 15) considered Shackle an Austrian even though Shackle considered himself a Keynesian.”
    Burger, P. 2003. Sustainable Fiscal Policy and Economic Stability: Theory and Practice, Edward Elgar, Cheltenham, UK. pp. 104-105.

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  20. One of Lachmann's attacks on the idea that market processes either result in neoclassical general equilibrium or other Austrian concepts of equilibrium:

    Ludwig M. Lachmann, "From Mises to Shackle: An Essay on Austrian Economics and the Kaleidic Society," Journal of Economic Literature 14.1 (1976): 54-62.

    This can be summed up as:

    "In a market process with subjective knowledge and subjective expectations, there is no tendency towards general equilibrium in the sense of overall market co-ordination. The market is instead 'a continuous process without beginning or end ..."

    David E. Andersson, Property rights, consumption and the market process, p. 4

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  21. I think that dogmas are the most difficult think to erradicate for some people. I may acknowledge that the market may be somewhat unstable in certain circumstances, but that doesn't necessarily makes me an interventionist.

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  22. "but that doesn't necessarily makes me an interventionist."

    I didn't say that. I said that the claim that markets are fundamentally unstable is usually the excuse given by interventionists of various stripes.

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  23. LK,

    cob.jmu.edu/rosserjb/UNCRTEXP.ECT.doc

    Is this a good introduction to subjective expectations? If not, could you give me some links?

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  24. Sounds like yor're having a tantrum because you can't refute the fact that one significant wing of Austrian eocnomists agree that subjective expectations cause instability of investment.

    Your statement above ("Austrians just state that there are sufficient market forces in the real world that tend to coordinate the actions of all these apparently uncoordinated planners ... ") is exposed as sheer ignorance.

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  25. "Sounds like yor're having a tantrum because you can't refute the fact that one significant wing of Austrian eocnomists agree that subjective expectations cause instability of investment."

    That it is significant is your claim. Incidentally, isn't this subjective expectations crap anything different from the old horse manure of animal spirits?

    Incidentally, do you have a theory of Capital? I suspect not. How whatever-Keynesian.

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  26. You know what I am doing to laugh these days? I'm reading "The General Theory of whatever...". The list of fallacies I can see as I read is mind-blowingly hilarious. It is all the more hilarious to see people falling for that goop.

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  27. Oops..

    " isn't this subjective expectations crap ....."

    should read

    " is this subjective expectations crap ...."

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  28. "subjective expectations crap "

    You're saying that the concept of "subjective expectations" is invalid or false??

    Here’s the Austrian Steve Horwitz making a comment on an earlier post:

    ”Of course expectations are subjective. What Austrian thinks otherwise?”

    Since all or at least the majority of Austrians think expectations are subjective, are you now saying that a concept held by all or at least the majority of Austrians is (in your eloquent words) “crap”? LOL…

    Do explain this.

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  29. As for "animal spirits, that concept is totally irrelevant to a modern Post Keyensian/Austrian theory of "subjective expectations"

    The term “animal spirits” was borrowed by Keynes from Descartes (Gerrard 1994: 15), and whether or not modern psychology provides support for Keynes’ idea that we have a “spontaneous urge to action rather than inaction” is irrelevant. The fundamental point is that there can be no genuine rationality in expectations (in, say, the neclassical expectations theory). Expectations are subjective, and the investment decision is essentially non-rational, and can change in a way fails to equate investment funds demand with supply.

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  30. "You're saying that the concept of "subjective expectations" is invalid or false??"

    No. I agree with Horwitz that all expectations are subjective because individuals form them. What is crap is the role you assign to it in economic analysis, especially saying that it makes investments unstable.

    Your subsequent post explains why I used the word crap. You said

    'Expectations are subjective, and the investment decision is essentially non-rational,'

    According to you, if it is subjective, it is non-rational. You are here revealing that you have a very interesting definition of the term 'rational'. As a student of the Austrian school who sees all action as rational, this is where I think your theory of subjective expectations is crap.

    Action presupposes an idea of a relationship of cause and effect between the action and the end whose satisfaction is sought. The very notion of seeing 'cause-effect' relationships presupposes rationality. It also presupposes that man ranks means through a subjective assessment of their ability to satisfy his ends. That man acts with all this presupposes that he has an expectation of an outcome. This is necessarily subjective. That does not make it non-rational. To label it non-rational is to say that there is action that is not purposeful. Hence, I am forced to conclude that your 'theory' which holds that because investment is based on subjective expectation, it is non-rational and hence unstable is crap.

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  31. "According to you, if it is subjective, it is non-rational. You are here revealing that you have a very interesting definition of the term 'rational'. "

    Your rant is a total waste of time.

    As I made it perfectly clear in my comments ("in, say, the neclassical expectations theory") I using "rational" here in the sense of neoclassical "rational expectations" theory, and in this sense "rational" just means decisions made by business when they can (allegedly) anticipate the future according to the objective probability distribution of future events.

    The very notion of seeing 'cause-effect' relationships presupposes rationality.

    If you use "rational" in a different sense, the sense of "all action is rational because it is purposeful", yes, the investment decision is "rational" even though it is still subjective. There is NO problem for Post Keynesian "subjective expectations" theory here.

    In short, an idiotic quibbling over the various and perfectly legitimate definitions the word "rational" can have in modern economics.

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