Robert P. Murphy, “Multiple Interest Rates and Austrian Business Cycle Theory.”On the Sraffa versus Hayek debate, Murphy has some valuable remarks. When Sraffa demonstrated that outside of equilibrium there is no single natural rate of interest in a barter or money-using economy, Hayek never really addressed this problem for his trade cycle theory.
Murphy points out the following:
“In his brief remarks, Hayek certainly did not fully reconcile his analysis of the trade cycle with the possibility of multiple own-rates of interest. Moreover, Hayek never did so later in his career. His Pure Theory of Capital (1975 [1941]) explicitly avoided monetary complications, and he never returned to the matter. Unfortunately, Hayek’s successors have made no progress on this issue, and in fact, have muddled the discussion. As I will show in the case of Ludwig Lachmann—the most prolific Austrian writer on the Sraffa-Hayek dispute over own-rates of interest—modern Austrians not only have failed to resolve the problem raised by Sraffa, but in fact no longer even recognize it.Murphy then discusses Lachmann’s (1994: 154) solution to Sraffa’s critique, but finds it wanting:
Austrian expositions of their trade cycle theory never incorporated the points raised during the Sraffa-Hayek debate. Despite several editions, Mises’ magnum opus (1998 [1949]) continued to talk of “the” originary rate of interest, corresponding to the uniform premium placed on present versus future goods. The other definitive Austrian treatise, Murray Rothbard’s (2004 [1962]) Man, Economy, and State, also treats the possibility of different commodity rates of interest as a disequilibrium phenomenon that would be eliminated through entrepreneurship. To my knowledge, the only Austrian to specifically elaborate on Hayekian cycle theory vis-à-vis Sraffa’s challenge is Ludwig Lachmann.”
(Murphy, “Multiple Interest Rates and Austrian Business Cycle Theory,” pp. 11–12).
“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.”On p. 14, Murphy states what I have already argued elsewhere: that Mises’s originary interest rate (a pure time preference theory of interest) becomes the “natural” rate imagined in Misesian versions of the trade cycle theory.
(Murphy, “Multiple Interest Rates and Austrian Business Cycle Theory,” pp. 14).
On pp. 19–23 in a simple model, Murphy provides his attempt to show how an inflationary increase in the money supply can cause “people in earlier periods to consume too much,” and his analysis in the (simple) model is fine, as far as it goes. But even he admits this is “not really an illustration of the Misesian trade cycle theory,” because his model does not “really exhibit malinvestments in longer production processes.” Murphy leaves the creation of such a model for his future research.
Murphy’s conclusions are significant:
“In summary, Austrians should familiarize themselves with the construct of a dynamic equilibrium, in which spot prices and other data can evolve over time, but where entrepreneurs fully anticipate such changes and squeeze out all pure profit opportunities. In this setting, there is no such thing as an objective real or natural rate of interest, so the Austrians cannot cling to their prescription that the banks ought to set the market rate to “the” natural rate. However, as our last scenario above hoped to convey, it still is true that an intertemporal, dynamic equilibrium can be disturbed if commercial banks inject new money into the credit markets. If a Misesian boom-bust cycle ensues, the reason is not that the banks charged a money right below “the” natural rate, because there is no such thing. Yet the basic Misesian analysis still holds true, that the bankers have suddenly augmented the purchasing power of one segment of the population, which not only redistributes real wealth but also leads to distorted money prices and more mistakes than otherwise would have occurred.”So Murphy has dispensed with the Wicksellian natural interest rate concept, but still thinks a Misesian boom-bust cycle can occur. But this of course raises the following questions:
(Robert P. Murphy, “Multiple Interest Rates and Austrian Business Cycle Theory,” p. 23).
(1) Fractional reserve banking has always redistributed “real wealth” to those who first receive loans: usually it goes to capitalists who increase investment, employment and output to make us wealthier. Why is this a bad thing? Even loans extended under a pure gold standard would redistribute “real wealth” to the first holders of the money: the issue is whether real resources are available.At any rate, I am impressed with this paper by Murphy. Though I have not become a convert to ABCT, without any doubt Murphy’s paper is the best attempt to improve and build on the Austrian trade cycle theory I have seen in a long time.
(2) What happens when new fiduciary media or fiat money can simply use idle resources, such as unemployed labour, unused stocks of raw materials, idle capital goods and other factor inputs?
(3) What happens when fiduciary media or fiat money can simply be used to import the relevant factor inputs through international trade, and these factor inputs are not scarce?
(4) Even when domestic factor inputs become scarce and an economy runs at full employment, and inflationary pressures build up, this is exactly the time when Keynesian macroeconomic policy has measures to deal with the boom: a contraction in demand to free up real resources for a further growth cycle.
BIBLIOGRAPHY
Lachmann, L. M. 1994. Expectations and the Meaning of Institutions: Essays in Economics (ed. by D. Lavoie), Routledge, London.
Murphy, Robert P. “Multiple Interest Rates and Austrian Business Cycle Theory.”
Murphy is rapidly converting into one of my favourite Austrians. I see that the main points raised by the ABCT are being dropped out in favor of a more realist approach. Even if we acknowledge that great injections of money during a prolonged period will cause a great redistribution of wealth and intertemporal discoordination, I really wonder how much of it is originally Misesian.
ReplyDeleteI think Austrians must rethink their theory as Murphy does, and stop calling it "the Austrian theory of the business cycles". I'm currenly being very nihilistic about the possibility of developing an ever-explaining theory of downturns and upturns, but of course there is plenty room for theorizing.
"Even if we acknowledge that great injections of money during a prolonged period will cause a great redistribution of wealth and intertemporal discoordination, I really wonder how much of it is originally Misesian."
ReplyDeleteAnd there need not even be "great" injections, just expansion in accordance with private sector demand, limited by financial regulation.
invanfoofoo, I can assure you that 99% of "it" (great injections of money subsidizing capitalists) is originally pure Keynesian ;)
ReplyDeleteI finally read the paper. You (voluntarily) forgot to mention that :
ReplyDelete"The [situation] would, however, be different if the actual supply of wheat were not changed, but if, under the mistaken impression that the supply of wheat would greatly increase, wheat dealers sold short greater quantities of future wheat than they will actually be able to supply. This is the only case I can think of where, in a barter economy, anything corresponding to the deviation of the money rate from the equilibrium rate could possibly occur. And if we assume that, in the community where this happens, wheat is the most important consumption good, then the consequences might be similar to those which occur when the money rate is below the equilibrium rate. (Sraffa 1932, pp. 246-247, italics original)
In this tantalizing passage, Hayek puts his finger on the crucial point: When the commercial banks flood the loan market with artificial credits, this causes producers to erroneously begin projects that are physically unsustainable. Specifically, the producers lengthen production processes as if the savings of real goods had increased (when in fact they have not). Thus, when Hayek laments that the banks cause a divergence of the money from the equilibrium rate of interest, he is referring to the fact that the false interest rate disrupts the intertemporal coordination between producers and consumers.
Sraffa clearly missed the entire essence of ABCT, because — as Hayek pointed out — Sraffa’s suggested barter example would actually increase the subsistence fund; it was (by stipulation) a mistake, but only because consumers would have preferred that some other goods had been produced rather than the increment in wheat output. In other words, Sraffa’s example of an erroneous (and unprofitable) increase in wheat production would not count as a “malinvestment” in the Misesian sense."
Contrary to what you think, ABCT holds true, and does not depend on "the" natural rate of interest. Simply, a business cycle occurs because investors are caught in the illusion that there are more wheat than actually available. That's all. Murphy mentions that, but you forgot to point it out also.
"Contrary to what you think, ABCT holds true, and does not depend on "the" natural rate of interest."
ReplyDeleteYou're wrong. If that were true the natural interest rate concept would been abandoned by Austrians a long time ago.
Instead, ALL the modern Austrians who work on ABCT continue to use the natural interest rate concept.
That there are one or more natural rate does not change anything to the premise. In a barter economy, economic agents do not invest more than the amount of their economies, which are not disproportionately misallocated to the higher stages of production. And this because all commodities are real economies, real subsistence fund. This is the essence of ABCT. In a regulated monetary economy (central bank, legal tender etc...), people mistakenly believe that there are more savings available to invest. Structure of production lengthens but there are not enough savings to support that huge investments/consumptions. You completely missed that point.
ReplyDeleteAnd I must add "all natural rates are equilibrium rates" insofar banks lend real savings since there is no distortion in time preference.
ReplyDelete"This is the essence of ABCT. In a regulated monetary economy (central bank, legal tender etc...), people mistakenly believe that there are more savings available to invest."
ReplyDeleteModern "regulated monetary economies" are open to international trade and often have considerable idle resources. What if the resources ARE available? The theory still does not work.
Furthermore, malinvestment in higher-order stages is still NOT a necessary effect, as Robert L. Vienneau shows:
"This paper demonstrates that the shape of a Hayekian triangle varies with the interest rate, even if real resources are not reallocated across stages of production. It is demonstrated, by an example, that no systematic tendency need exist for entrepreneurs to respond to lower interest rates by reallocating resources from producing low order goods to producing higher order goods, or otherwise increasing the capital-intensity of the structure of production. The rejection, as is typical of Garrison and others in the modern Austrian school of economics, of a physical measure of the average period of production and of a production function with an aggregate measure of capital as an argument is not sufficient for rigorous capital theory. Hayekian triangles are arguably not a good tool for investigating or explaining capital theory."
Vienneau, R. L. 2006. “Some Fallacies of Austrian Economics,” September
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=921183
Vienneau, R. L. 2010. “Some Capital-Theoretic Fallacies in Garrison’s Exposition of Austrian Business Cycle Theory,” September 4
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1671886
And Hayekian versions of ABCT are still subject to Kaldor's critique:
ReplyDeleteKaldor, N. 1939. “Capital Intensity and the Trade Cycle,” Economica n.s. 6.21: 40–66.
Kaldor, N. 1940. “The Trade Cycle and Capital Intensity: A Reply,” Economica n.s. 7.25: 16–22.
Kaldor, N. 1942. “Professor Hayek and the Concertina-Effect,” Economica n.s. 9.36: 359–382.
OK, I read the two papers (the '2006' and '2010'). And... what ? His critique is nothing but strawman. You make me waste my time. Thanks, LK.
ReplyDeleteOne more thing. Kaldor was wrong. De Soto already slashed him into pieces. You want to critique ABCT, it's OK, but you should better understand ABCT before (you can read Rothbard and De Soto's works). To say "Sraffa wins the Sraffa-Hayek debate" just because there are many natural rates is to misunderstand the essence of ABCT. Interest rate (which is determined by time preference) is the price of savings. Low time preference = low interest rate(or rates). High time preference = high interest rate(or rates).
"To say "Sraffa wins the Sraffa-Hayek debate" just because there are many natural rates is to misunderstand the essence of ABCT."
ReplyDeleteA unique natural rate of interest in a growing monetary economy that is different from the bank rate IS the basis of the Hayekian versions of ABCT.
I re-read the 2010 paper. Seriously, Vienneau never dealt with time preference. Instead, he dealt with... CCC and Capital Reswitching. But time preference is the key point. Manipulating interest rates leads to a distorted time preference, cash holdings cannot absorb any additional money. Overexpansion only leads to capital consumption. Banks do not lend real savings. Investments exceed savings. In the long run this is unsustainable.
ReplyDelete"A unique natural rate of interest in a growing monetary economy that is different from the bank rate IS the basis of the Hayekian versions of ABCT."
You stubborn. Re-read this :
"Let us take Mr. Sraffa’s case in which the farmers « arbitrarily changed » the quantity of wheat produced ... so increased the supply of wheat that its price fell below its cost of production and ... loans of wheat were made at a much lower rate of interest than loans of other commodities. But would that fall in the rate of interest on wheat-loans cause anyone to start roundabout processes of production for which the available subsistence fund is not sufficient ? There is no reason whatever to assume this. In so far as people live on wheat, they will actually be provided with food for a longer period; and in so far as the lower price of wheat will induce people to eat more of it – instead of something else – these other goods will also be available for a longer period of time, and interest in terms of these goods will also fall. The effects will be just the same as if a corresponding amount of wheat had been saved, and when, as a consequence of the fall in the price of wheat, its output falls again, the accumulation of capital made possible by the surplus of wheat will supply cease.
...
The case would, however, be different if the actual supply of wheat were not changed, but if, under the mistaken impression that the supply of wheat would greatly increase, wheat dealers sold short greater quantities of future wheat than they will actually be able to supply. This is the only case I can think of where, in a barter economy, anything corresponding to the deviation of the money rate from the equilibrium rate could possibly occur."
In an unregulated economy, economic agents do not invest more than the amount of their economies.
"But time preference is the key point. Manipulating interest rates leads to a distorted time preference, cash holdings cannot absorb any additional money. Overexpansion only leads to capital consumption. Banks do not lend real savings. Investments exceed savings."
ReplyDeleteYou assume an economy at full employment and full use of resources, with no international trade.
"In an unregulated economy, economic agents do not invest more than the amount of their economies."
ReplyDeleteIn "an unregulated economy"??
You mean in a BARTER economy, with NO money, and NO trade. That is the only condition where people would be limited to investing the stock of real commodities.
"That is the only condition where people would be limited to investing the stock of real commodities."
ReplyDeleteNo. In a monetary economy, not barter economy, under those two conditions : central bank and legal tender.
"Yet the basic Misesian analysis still holds true, that the bankers have suddenly augmented the purchasing power of one segment of the population, which not only redistributes real wealth but also leads to distorted money prices and more mistakes than otherwise would have occurred."
ReplyDeleteIs this actually true though once the lack of natural rate is acknowledged? The natural rate was the one that dictated the amount of loans that "should" have been made -- everything beyond these being doomed-to-fail "malinvestments". But without this natural rate there is no (market/Austrian) basis upon which we can say that a loan should or should not have been made. If you don't have a natural rate the whole normative dimension of ABCT falls away. Investments that are made at, say, a 1% as opposed to a 2% rate of interest cannot be judged based on the rate of interest alone because there is no natural rate and so there is no standard against which to judge the rate of interest.
The whole theory stands or falls based on the natural rate. Without it we would have to make judgements about the rate of interest based on other measures, such as employment or inflation.
You are right, Philip.
DeleteIn any case, whether investments go ahead or not is dependent on wider factors than just interest rates rises.
Banks regularly finance loans, and expectations of profit go well beyond mere interest rates.