Hayek’s Natural Rate on Capital Goods, Sraffa and ABCT

Consider this passage from Hayek’s Prices and Production (2nd edn.; 1935):

“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 2008 [1935]: 215).

This passage illustrates a fundamental reason why Sraffa’s critique of Hayek was so important. In Sraffa’s analysis of Hayek’s theory, we see that

(1) the relevant market for the “demand for and the supply of capital” is the market for capital goods. Depending on how one defines “saving” (see Pollin 2003: 304–308) and “investment,” the demand for capital that is met results in investment (if savings is defined simply as “income not spent,” savings can exceed investment when money or even goods are held without lending for capital goods investment).

(2) By the words

“because the demand for and the supply of capital do not meet in their natural form but in the form of money,”

Hayek is referring to the idea of loans being made in natura (in real commodities), as opposed to in money terms.

(3) A state where loans are made in in natura is a barter state (or, more correctly, a credit/debt transaction where real goods are lent out and repayed with interest with some other goods later). What would a rate of interest be when loans are made in goods? The rate of interest would be the rate on loans of a physical commodity or commodities (Sraffa 1932: 49–51). In a world of heterogeneous goods as factor inputs (including capital goods) which is out of equilibrium, there could be as many natural rates on each commodity considered as a factor input (or capital good) as there as such commodities (Barens and Caspari 1997: 288).

(4) Which one of these rates would in fact be the “natural rate”? There is no unique natural rate, but multiple rates. Any monetary rate could be both above and below a number of multiple natural rates, or, as Lachmann stated, “it is evidently possible for the money rate of interest to be lower than some [sc. multitude of commodity rates] but higher than others” (Lachmann 1994: 154). In short, one should agree with Robert P. Murphy, who concludes that “canonical ABCT does need to be updated, in light of a crippling objection raised early on by Piero Sraffa (1932a, 1932b) [my emphasis]” (see “Multiple Interest Rates and Austrian Business Cycle Theory,” p. 1).

(5) It therefore makes no sense to speak of a monetary rate of interest diverging from the unique Wicksellian natural rate of interest (or what Hayek calls the equilibrium rate), because there is no such rate outside of an imaginary equilibrium position.

(6) If some average of multiple natural rates were constructed, would this get Hayek out of his conundrum? No. As Sraffa argued,

“I pointed out that only under conditions of equilibrium would there be a single rate; and that when saving was in progress there would at any one moment be many ‘natural’ rates, possibly as many as there are commodities; so that it would be not merely difficult in practice, but altogether inconceivable, that the money rate should be equal to ‘the’ natural rate. And whilst Wicksell might fall back, for the criterion of his ‘money’ rate, upon an average of the ‘natural’ rates weighted in the same way as the index number of prices which he chose to stabilise, this way of escape was not open to Dr. Hayek, for he had emphatically repudiated the use of averages. Dr. Hayek now acknowledges the multiplicity of the ‘natural’ rates, but he has nothing more to say on this specific point than that they ‘all would be equilibrium rates.’ The only meaning (if it be a meaning) I can attach to this is that his maxim of policy now requires that the money rate should be equal to all these divergent natural rates.” (Sraffa 1932b: 251).

Lachmann also noted that Wicksell’s natural rate could be interpreted as an average of actual own-rates in a barter economy (Lachmann 1978: 76–77), and later tried to defend the natural rate idea.

For Lachmann’s attempts to salvage the notion of a natural rate, see Lachmann (1978: 75–77) and Lachmann (1986: 225–242). See Robert P. Murphy (2003) and Murphy’s paper “Multiple Interest Rates and Austrian Business Cycle Theory” for why Lachmann’s solution does not work.

BIBLIOGRAPHY

Barens, I. and V. Caspari, 1997. “Own-Rates of Interest and Their Relevance for the Existence of Underemployment Equilibrium Positions,” in G. C. Harcourt and P. A. Riach (eds.), A “Second Edition” of The General Theory (Vol. 1), Routledge, London. 283–303.

Hayek, F. A. von, 1932. “Money and Capital: A Reply,” Economic Journal 42 (June): 237–249.

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.

Lachmann, L. M. 1978. Capital and its Structure, S. Andrews and McMeel, Kansas City. pp. 75–77.

Lachmann, L. M. 1986. “Austrian Economics under Fire: The Hayek-Sraffa Duel in Retrospect,” in W. Grassl and B. Smith (eds.), Austrian Economics: Historical and Philosophical Background, Croom Helm, London. 225–242. [reprinted in Lachmann 1994: 141–158.]

Lachmann, L. M. 1994. Expectations and the Meaning of Institutions: Essays in Economics (ed. by D. Lavoie), Routledge, London. 141–158.

Murphy, Robert P. 2003. Unanticipated Intertemporal Change in Theories of Interest, PhD dissert., Department of Economics, New York University.

Murphy, Robert P. “Multiple Interest Rates and Austrian Business Cycle Theory.”

Pollin, R. 2003. “Saving,” in J. E. King (ed.), The Elgar Companion to Post Keynesian Economics, Edward Elgar, Cheltenham, UK and Northhampton, MA, USA. 304–308.

Sraffa, P. 1932a. “Dr. Hayek on Money and Capital,” Economic Journal 42: 42–53.

Sraffa, P. 1932b. “A Rejoinder,” Economic Journal 42 (June): 249–251.


UPDATED BIBLIOGRAPHY ON THE HAYEK–SRAFFA DEBATE

Barens, I. and V. Caspari, 1997. “Own-Rates of Interest and Their Relevance for the Existence of Underemployment Equilibrium Positions,” in G. C. Harcourt and P. A. Riach (eds.), A “Second Edition” of The General Theory (Vol. 1), Routledge, London. 283–303.

Bellofiore, R. 1998. “Between Wicksell and Hayek: Mises’ Theory of Money and Credit Revisited,” American Journal of Economics and Sociology 57.4: 531–578.

Burger, P. 2003. Sustainable Fiscal Policy and Economic Stability: Theory and Practice, Edward Elgar, Cheltenham, UK.

Caldwell, B. 2004. Hayek’s Challenge: An Intellectual Biography of F.A. Hayek, University of Chicago Press, Chicago and London.

Cottrell, A. 1993. “Hayek’s Early Cycle Theory Re-examined,” Cambridge Journal of Economics 18: 197–212.

Harcourt, G. C. and P. A. Riach. 1997. A “Second Edition” of The General Theory (Vol. 1), Routledge, London.

Hayek, F. A. von, 1931. Prices and Production, G. Routledge & Sons, Ltd, London.

Hayek, F. A. von, 1932. “Money and Capital: A Reply,” Economic Journal 42 (June): 237–249.

Hayek, F. A. von, 1935. Prices and Production (2nd edn), Routledge and Kegan Paul.

Hicks, J. R. and J. C. Gilbert. 1934. Review of Beiträge zur Geldtheorie by F. A. von Hayek, Economica n.s. 1.4: 479–486.

Kurz, H. D. 2000. “Hayek-Keynes-Sraffa Controversy Reconsidered,” in H. D. Kurz (ed.), Critical Essays on Piero Sraffa’s Legacy in Economics, Cambridge University Press, Cambridge. 257-302.

Kyun, K. 1988. Equilibrium Business Cycle Theory in Historical Perspective Cambridge University Press, Cambridge. p. 36ff.

Lachmann, L. M. 1978. Capital and its Structure, S. Andrews and McMeel, Kansas City. pp. 75–77.

Lachmann, L. M. 1986. “Austrian Economics under Fire: The Hayek-Sraffa Duel in Retrospect,” in W. Grassl and B. Smith (eds.), Austrian Economics: Historical and Philosophical Background, Croom Helm, London. 225–242. [reprinted in Lachmann 1994: 141–158.]

Lachmann, L. M. 1994. Expectations and the Meaning of Institutions: Essays in Economics (ed. by D. Lavoie), Routledge, London. 141–158.

Lawlor, M. S. and Horn, B. 1992. “Notes on the Hayek–Sraffa Exchange,” Review of Political Economy 4: 317–340.

Lawlor, M. S. 1994. “The Own-Rates Framework as an Interpretation of the General Theory: A Suggestion for Complicating the Keynesian Theory of Money,” in J. B. Davis (ed.), The State of Interpretation of Keynes, Kluwer Academic, Boston and London. 39–90.

Milgate, M. 1979. “On the Origin of the Notion of ‘Intertemporal Equilibrium,’” Economica n.s. 46.181: 1–10.

Murphy, Robert P. 2003. Unanticipated Intertemporal Change in Theories of Interest, PhD dissert., Department of Economics, New York University.

Murphy, Robert P. “Multiple Interest Rates and Austrian Business Cycle Theory.”

Myrdal, G. 1965 [1939]. Monetary Equilibrium, Augustus M. Kelly, New York.

Sraffa, P. 1932a. “Dr. Hayek on Money and Capital,” Economic Journal 42: 42–53.

Sraffa, P. 1932b. “A Rejoinder,” Economic Journal 42 (June): 249–251.

Vaughn, K. I. 1994. Austrian Economics in America: The Migration of a Tradition, Cambridge University Press, Cambridge and New York.