Friday, June 28, 2013

Mises’s “Originary Interest”: Another Useless Real Theory of the Interest Rate

Mises’s definition is as follows:
“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 2008: 523).
First, this is quite clearly a real theory of the interest rate, in which present real goods exchange for future real goods, or in other words where loans are imagined as occurring in natura. The “originary interest” is a ratio. Mises describes it as the “discount of future goods as against present goods” (Mises 2008: 521).

In terms of capital goods, the “originary interest rate” arising in Mises’s equilibrium world called the “evenly rotating economy” (ERE) would be the same as the Wicksellian natural rate of interest.

Mises asserts that there is “a tendency toward the equalization of this ratio for all commodities,” but this is unconvincing. Nor can there ever be a single “originary interest rate” outside of purely imaginary equilibrium states.

Mises has his own monetary or market rate of interest on loans called the “gross money rate of interest” (Mises 2008: 534). Mises conceives the “gross money rate of interest” as being determined by other factors in addition to originary interest, as follows:
(1) the entrepreneurial component: interest determined by the speculative element in money lending and the dangers involved (Mises 2008: 536–538).

(2) the price premium: an additional element in interest to take account of expected changes in inflation or the general price level (Mises 2008: 538–542).
In Austrian theory, unfettered market interest rates – or ideal laissez faire gross money rates of interest – are supposed to gravitate towards an “originary interest rate” or Wicksellian natural rate of interest, and thereby allocate resources effectively in an intertemporal sense. By this process, a monetary interest rate is supposed to move towards a natural rate of interest so that his coordinates resources and provides intertemporal coordination of investment projects with real resources.

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. 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 even though the banks’ monetary interest rates – even in a free banking system – might converge in a spread, there could be vast differences between the spread of banks rates and many individual commodity natural rates.

The Austrian theory of interest rates – either the monetary rate or the (alleged) real rate – is grossly unrealistic and flawed.

First, in any advanced capitalist economy, people are generally lending and borrowing money, not real goods. How can a convergence to a “real” originary rate on goods emerge when borrowing is not in barter loans, but in terms of money?

Secondly, the nature of monetary interest rates in a market economy, and even hypothetical free market ones, is not described by time preference theory.

In any capitalist economy, there will generally be a stock of money used to buy and sell assets on secondary markets (whether real or financial markets). This money can be diverted to use in lending or clearing of loans for capital goods investments. Even if one were to use loanable funds model, a decrease in liquidity preference can increase funds available for lending without a corresponding decrease in consumption, since it might be merely money previously used on secondary asset markets or dishoarded. Such shifts are merely just changes in the liquidity of assets held in a person’s portfolio, not changes in time preference. Therefore changes in monetary interest rates even in some hypothetical free market system need not necessarily communicate any significant information about time preference or even any meaningful information at all.

Even when people abstain from consumption and save money, it does not follow that their saving now will entail a consumption expenditure in the future. Resources may not have been consumed now, but it does not follow that the eventual output of those resources in a capital goods project will be demanded in the future.

To sum up, one can say that:
(1) a decision to save money now does not entail a future consumption purchase;

(2) saved money now need not be invested in capital goods projects, and may be used to buy secondary assets (either real or financial). A large stock of money is at any one time tied up in purchases and sales of secondary assets;

(3) money made available for capital goods investments may have simply been shifted from purchasing of secondary assets (either real or financial) and not from abstention from consumption, and there need be no change in time preference, only liquidity preference.

(4) changes in monetary interest rates, even in hypothetical free market economies, need signal no reliable information and indeed no information at all about time preference or real resource availability.
Maclachlan, Fiona C. 1993. Keynes’ General Theory of Interest: A Reconsideration. Routledge, London.

Mises, L. 2008. Human Action: A Treatise on Economics. The Scholar’s Edition. Ludwig von Mises Institute, Auburn, Ala.


  1. Hasn't the multiple natural rates thing that you bring up been addressed pretty definitively by Lachmann, Keynes and Hayek ? (see:

    "Own" rates of interest need to take account not only the originary rate but also the expected net return from holding any particular asset. There will indeed be multiple own-rates but they will (in equilibrium) all be aligned when you take the expected differences in expected net return into account.

    The money rate of interest will then be the originary rate adjusted for the expected net return from holding money. An approximation for this would be that the money rate of interest is the originary rate of interest adjusted for expected changes in the price level (and in productivity) in the future.

    1. None of this rescues the natural rate as conventionally defined by Austrians, nor time preference theory of monetary interest rates.

    2. BTW: Your point 3 is incorrect.

      Start with a position where equal sums of money are spent on new consumption and new investment goods. Assume that in addition some fixed proportion of the money supply just circulates around amongst people buying used assets from each other.

      One day everyone decides to stop buying used assets and instead buys new cap[ital goods.

      As a result total spending on consumer goods stays the same and total spending on investment goods increases. This represents an increase in the proportion of spending on investment goods.

      In what sense is that not a change in time preference ?

      (Compare with a situation where people switch from used goods and spend on both new consumer goods and new investment goods in the same ratio as before. )

    3. "As a result total spending on consumer goods stays the same and total spending on investment goods increases. This represents an increase in the proportion of spending on investment goods.

      In what sense is that not a change in time preference ?"

      Your theory models a capitalist economy at full employment/no significant idle resources. The increase in spending on capital goods has not been backed by real saving. Therefore the new capital goods projects are unsustainable.

      That is according to the logic of your theory.

    4. An increase in savings would be represented (in money terms) by a higher % of income being saved , right ?

      In this case this savings change (based on our assumption) from 50% of income to something more than 50%. Assuming this ratio continues after the initial switch from spending on used goods to new goods turns into income streams then this has to represent an increase in savings.

  2. Note how Mises banishes uncertainty and historical time when it stops suiting him. The whole idea of his originary rate of interest relies on the idea that people are only interested in "saving" commodities -- oil now versus oil in the future etc. -- and that they are not interested in using them as speculative investment vehicles. This can be seen again here:

    "the entrepreneurial component: interest determined by the speculative element in money lending and the dangers involved"

    The "speculative element" here is actually perfectly priced risk -- it is not speculative at all. The assumption is that en masse savers will lend at the "correct" interest rates. They will price in risk correctly and there will not be a wave of speculation and defaults (that only happens when the central bank lowers the money rate of interest).

    So, what Mises does is throw out the whole idea of uncertainty when it stops suiting his ideological purposes. Typical Austrian.

    Of course the irony is that many Miseans are learning today that "originary rates of interest" do not just rely on some sort of time preference. And their gold turns to lead in their hands as their savings are completely wiped out. Sorry guys! Bad in theory, bad in practice!

    1. Phil.Notice how both Mises and Hayek use the Wicksellian natural rate,long after Wicksell himself have found it was useless.But i many times wonder if they really believe in the idiosyncratic melting pot of ideas they promote,that all have in common that were passe´ even in the time of first and second generation of their branch .Old Banking school ,A-Priori Rationalism,even old 1400 century philosophers from Salamanca are used as references,but only when it suits their purpose to promote their ideology.It certainly looks like pure muddy,aristocratic old conservatism to me,an excentric speech from some 1900 century Peer in House of Lord that read some books.When i read something from Mises, an old John Stuart Mill sentence, comes to my mind: "Conservatives are not necessarily stupid, but most stupid people are conservatives."

    2. That's actually an interesting point, Jan. Yes, the Austrian theory is indeed something of a hodgepodge. I never really thought about it that way. But that probably explains the element of disorganisation in the theory. One moment uncertainty matters, the next it is ignored. One moment empirical statements are made, the next they are said to be unnecessary etc. etc.

    3. "One moment uncertainty matters, the next it is ignored"

      Have you ever considered the possibility that Mises sometimes employs simple models where uncertainty is assumed away (to illuminate specific points) and sometimes more complex models where uncertainty is brought back in again?

      Any reasonable reading of Mises would surely show that uncertainty is very key and that he uses simplifying devices like ERE to abstract away from this uncertainty as part of the process of explaining his theories one layer at a time.

    4. No, Rob. Because the two things are entirely inconsistent with each other. They're mutually contradictory. Austrians seem to have the virtue of being able to hold contradictory ideas in their heads at the same time. The rest of us lack this ability.

      In the case of the Austrian theory of interest and the business cycle, these ideas literally do not work if we assume uncertainty. They fall apart completely. As do most Austrian ideas that rely on rational agents finding the "correct" price for X, Y or Z. You want to have your cake (uncertainty) and eat it (perfect market pricing), but you can't. And everyone outside of the initiated can see that your theories are contradictory and nonsensical. I personally suspect that the reason Austrians continue to hold these beliefs even when they're shown to be illogical is because they carry emotional and ideological weight which overwhelms the rational centers of thought. They are thus, as the psychologists might say, "passionate attachments" and not theories based on reasoned judgment.

  3. Hey LK, I need a favour. I need the clearest representative statement by the Austrian school that lowering the money rate of interest below the natural rate causes speculative bubbles. Thanks.

    1. The Austrian Mark Skousen makes a pretty clear statement of that here:

      According to the Austrian/Swedish theory of the business cycle, when the central bank (Fed) lowers interest rates below the “natural” rate, it creates an artificial boom and asset bubbles that cannot last. Market interest rates inevitably will rise and choke off the boom, causing a crash, recession and bear market.

    2. That's perfect. Thank you.

      Any idea is Skousen is another gold scammer?

  4. Thank you Lord Keynes.This was interesting!I never heard of any "Austrian/Swedish theory of the buisness cycle" but more often of "Keynesian and Stockholm-school tradition of cumulative (disequilibrium) cycle" .What this Skousen should refer to is of course Knut Wicksell´s Cumulative process as he described it at the time when he wrote Interest and Prices,1898.No more no less.

  5. "Outside of general equilibrium, there can be as many natural rates as there are capital goods commodities lent out." This is correct and the Austrian interpretation of Wicksell's theory is generally unhelpful. Sraffa pointed this out in his critique of Hayek's Prices & Production. However the Swedish neo-Wicksellian interpretation accepts the notion of credit disequilibrium and argues that it is in fact possible to generate aggregate proxies of the natural rate from company accounts. Ie macro economics based on micro-foundations. The natural rate is an extremely useful theoretical construct if economists want to understand the nature of credit economies. Since 2010 the US natural rate has risen considerably where as the UK rate has fallen quite dramatically. Von Mises wrongly assumes that the natural rate is constant. Keynes rightly argued that it could change dramatically(Chapter 22 General theory - Notes on the Trade Cycle)

  6. I've been trying to understand this concept: "Outside of general equilibrium, there can be as many natural rates as there are capital goods commodities lent out." I am by no means an economist but I would really really like to understand what this means. Could LK or someone else give me a theoretical example? How would this work in a real world libertarian society and why does it eliminate the idea of ABCT?

    Does this mean an entrepreneur who builds televisions would go to a bank and have different rates of interest when they buy wires, the glass used, the plastics inside, the circuits, bulbs, etc.?

    Anyway, great work LK and thanks for any answers in advance.

    1. ""Outside of general equilibrium, there can be as many natural rates as there are capital goods commodities lent out." I am by no means an economist but I would really really like to understand what this means"

      A Wicksellian natural rate of interest is a market clearing, barter interest rate on each and every capital good lent out, and the interest rate is a real rate in terms of goods. E.g., I lend 500 tons of steel and for example, drop my interest down, say, to 3 tons of interest per annum until I can clear my market.

      Outside of a general equilibrium, there would be no single rate that would clear all these vast heterogeneous capital goods markets, and in theory as many such rates there are heterogeneous goods being offered to loan out .

      I think this post clarifies all these concept involved in the natural rate:

    2. LK. Maybee those papers may interest you?


      Monetary Equilibrium-Claes Henrik Siven -

      On Prices in Myrdal’s Monetary Theory
      Alexander Tobon*

      Myrdal, growth processes and
      equilibrium theories
      Carlo Panico and Maria Olivella Rizza