It is well known that Wicksell’s unique “natural rate of interest” was taken over by Mises and Hayek in their early formulations of the Austrian business cycle theory (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.Let us set out the analysis in the following points:
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 : 215).
(1) The “natural rate of interest” is a non-monetary theory of the interest rate, and is independent of money and credit (Rogers 1989: 27). It is supposedly the centre of gravity towards which the monetary rate converges (Rogers 1989: 27).FURTHER READING
(2) The condition where loans are made in natura is a barter state (or, more correctly, a credit/debt transaction where real goods are lent out, and then repayed with interest in terms of other goods later). What would a rate of interest be when loans are made in goods?
The “natural rate of interest” would be the rate on loans of a physical commodity or commodities (Sraffa 1932: 49–51). 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 (Barens and Caspari 1997: 288).
(3) 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 (whether durable or non-durable capital). These capital loan markets in natura – the markets in real capital goods lent out without money – will have market clearing with a natural rate.
This point is brought out by Lachmann in his observations on the Hayek–Sraffa debate:“One thing is clear: when Hayek and Sraffa use the word ‘equilibrium’ they use it to denote quite different things. For Hayek it means market-clearing demand-and-supply equilibrium, for Sraffa long-run cost-of-production equilibrium.” (Lachmann 1994: 153).(4) Therefore real savings and investment are equated: no intertemporal discoordination (or future lack of capital goods in relation to current plans) will result.
But the natural rate of interest can only be a single rate inside general equilibrium (or in some other equilibrium state such as Mises’s “final state of rest” or the ERE). Outside of general equilibrium, there can be as many natural rates as there are capital goods commodities lent out.
(5) therefore (by the internal logic of Hayek’s theory) 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 as a unique “natural rate.”
(6) therefore (by the internal logic of Hayek’s theory) 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’ monetary interest rates – even in a free banking system – converge in a spread, yet there could be vast differences between the spread of banks rates and many individual commodity natural rates.
(7) 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 ideal or consistent intertemporal coordination.
The only way is: to abolish money and return to a barter system (but even then there is no reason why “own commodity equilibrium rates” must exist on each type of capital good available for investment).
(8) Furthermore, 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.
A possible and likely mismatch between planned investment and available real future savings is perfectly possible in a world of uncertainty, subjective expectations, entrepreneurial error, and even investment financed via retained earnings.
But question is: do these possible intertemporal discoordination problems really cause severe economic problems in real world market economies, and do they produce the type of trade cycle imagined in the Austrian business cycle theory?
The Austrian business cycle theory requires that booms develop with full employment and a lack of resources, but ignores the fact that virtually all modern economies are open to international trade and even at full employment still have idle capacity in many sectors (which overcome scarcity problems for many investments made in the past).
The theory requires a full use of resources (modelled in a closed economy) that only really occurs in fictitious states of general equilibrium.
The theory also requires a real world tendency to general equilibrium that does not exist in modern market economies.
“The Natural Rate of Interest: A Wicksellian Fable,” June 6, 2011.BIBLIOGRAPHY
“Austrian Business Cycle Theory (ABCT) and the Natural Rate of Interest,” June 18, 2011.
“Austrian Business Cycle Theory: The Various Versions and a Critique,” June 21, 2011.
“Hayek on the Flaws and Irrelevance of his Trade Cycle Theory,” June 29, 2011.
“Robert P. Murphy on the Sraffa-Hayek Debate,” July 19, 2011.
“Bibliography on the Sraffa-Hayek Debate,” July 20, 2011.
“Robert P. Murphy on the Pure Time Preference Theory of the Interest Rate,” July 13, 2011.
“Lachmann on Trade Cycle Models,” August 27, 2011.
“ABCT without a Unique Natural Rate of Interest?,” September 22, 2011.
“ABCT and the Flow of Credit,” October 6, 2011.
“Hayek’s Natural Rate on Capital Goods, Sraffa and ABCT,” December 27, 2011.
“Hayek’s Trade Cycle Theory, Equilibrium, Knowledge and Expectations,” January 4, 2012
“Equilibrium Amongst the Austrians,” January 28, 2012.
“Hülsmann on Mises’s Business Cycle Theory,” February 11, 2012.
“Why Isn’t the Boom of 1946-1948 a Problem for Austrians?,” June 2, 2012.
“Bruce Caldwell on the Flaw in Hayek’s Early Business Cycle Theory,” July 8, 2012.
“Repapis on Hayek’s Business Cycle Theory,” October 10, 2012.
“Hayek on his Simplified Capital Theory Assumptions in Prices and Production,” October 15, 2012.
“Critics of the Classic Hayekian Business Cycle Theory,” December 13, 2012.
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, 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. 1994. Expectations and the Meaning of Institutions: Essays in Economics (ed. by D. Lavoie), Routledge, London. 141–158.
Rogers, C. 1989. Money, Interest and Capital: A Study in the Foundations of Monetary Theory. Cambridge University Press, Cambridge.
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.
Sraffa, P. 1932. “Dr. Hayek on Money and Capital,” Economic Journal 42: 42–53.
'(5) therefore (by the internal logic of Hayek’s theory) 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 as a unique “natural rate.”'ReplyDelete
This is very confused.
In a barter system where loans are made in many different commodities each one would have an own-rate of interest. This would reflect the underlying natural rate of interest plus expectations about each commodities expected change in relative value with respect to other commodities. In equilibrium all these rates would be aligned. Out of equilibrium there will be arbitrage opportunities that will tend to move them towards alignment. Equilibrium doesn't mean they will all be the same value - just that they all will reflect the same expectations about future price movements.
Lachmann explains why this doesn't present any particular theoretcial problem
Move away from a barter economy to a monetary one. All loans are made in money. There will be different interest rates to reflect different terms and different risks - but what has this got to do with multiple own-rates of interest for different commodities? One set of interest rates (the natural rate) will allow market participants to align their plans for production and consumption at an optimal level.
Hayek's theory is that if the banking system creates too much money and causes the interest rates to drop below this equilibrium then this will create a tendency for distortions in the price structure that will favor too much long term investments than can be sustained by the structure of demand in the economy (cause people's plans to become mis-alligned).
" Out of equilibrium there will be arbitrage opportunities that will tend to move them towards alignment."Delete
Even if you accept that argument, there will still be multiple rates, unless you get to a GE state (which will never happen).
None of this will salvage the ABCT based on the natural rate.
"There will be different interest rates to reflect different terms and different risks - but what has this got to do with multiple own-rates of interest for different commodities? "
Very little. That's why monetary rates will never align with own rates.
The whole theory is incoherent.
Can you explain why you think that in a money economy where all loans are issued in money there will be multiple rates (one for each commodity) ?Delete
I am missing why there would be.
However, even if there were (as there would under barter in theory) Lachmann shows how they would align.
Now of course in the real economy prices and interest rates are constantly out of equilibrium. This doesn't mean that equilibrium doesn't exists - just that things move too fast in the economy for everyone plans to be fully correlated.
But Hayek's theory is about what happens if one variable in the economy (interest rates) is deliberately lowered below its equilibrium rate. Like a lot of economic theories (including ones used by post-Keynsians) it can best be demonstrated in a model where equilibrium is assumed to exists. But this in no way means it fails to operate in a world of dis-equilibrium - just that it will not be seen in the pure form of the model.
Straffa tried to say that Hayek's theory was incoherent because the concept of a "natural" rate of interest didn't exists as a result of multiple own rates existing in a barter economy.
Lachmann successfully refuted this charge by showing how even if the economy should be treated as a barter economy with multiple own-rates this did not stop there being an equilibrium set of rates around which the economy would tend to allign.
Now: You can reject Hayek's theory on other grounds but I don't think you can use Straffa any more - Lachmann has shown his arguments to be invalid
(1) please look at the way Hayek defined the natural rate:Delete
"“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. "
The natural rate is non-monetary rate. It is imagined as an equilibrium rate on loans made in real goods. But there could be as many natural "equilibrium" rates in a barter economy as there are commodities lent out (as capital goods).
Is this not clear?
(2) "But Hayek's theory is about what happens if one variable in the economy (interest rates) is deliberately lowered below its equilibrium rate. "
No, it is about how a monetary/bank rate is pushed below a single natural rate. That rate does not exist outside equilibrium. So which "natural rate" (there might be thousands)?
(3) No, Sraffa said no monetary rate can equal multiple natural rates.
(4) "Lachmann successfully refuted this charge by showing how even if the economy should be treated as a barter economy with multiple own-rates this did not stop there being an equilibrium set of rates around which the economy would tend to allign."
Not sure if this is exactly what Lachmann thought he showed, but what use is that in monetary economy? It is irrelevant.
(5) and, yes, the whole theory is unsound because its GE assumptions (the real existence of natural rates of interest, either monetary or in barter loans) is not true.
And regarding Lachmann's argument, Bob Murphy's comment here is as good an explanation as you can get:Delete
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.
I think Bob is over-complicating this issue. Lachmann explained how the multiple-rates are derived and while this indeed means that in a barter-economy there will be no one natural rate , in a money economy it is only the natural rate for money that matters - it (plus money prices) will encapsulate information about all other goods interest ratesDelete
Bob has promised a more detailed post to explain his views - I will wait until that appears to comment further.
In other words "you can’t look at the equlibrium barter economy and tell me what “the natural rate” is supposed to be, even in principle" is a true statement but irreverent since in a money economy the only natural rate that matters is for money - though interest rates for other goods could in theory be derived based on expectations about their future money prices.Delete
Excellent Lord Keynes!And here is some good explanaitions how those ideas have got such wide spreading:Thom HartmannReplyDelete
and this article by:
Mike Davis-New Left Review 79, January-February 2013