More Fake History of the Great Depression

I refer readers to this post by Robert P. Murphy:

Robert P. Murphy, “Does Anyone Deny That There Were Unprecedented Credit Stimulus Policies During Hoover Administration?,” 27 September.

Here is Murphy’s question to Keynesians:

“In my book on the Great Depression [Murphy 2009 – LK], I quote Lionel Robbins saying (I think in 1934) that central banks around the world had tried unprecedented measures to stimulate a recovery through cheap credit, and that this was a complete reversal of traditional central bank doctrine. ….

But I’m asking, do you [sc. Keynesians – LK] agree with Robbins, Hayek, and the random Joes writing letters to the NYT, who at the time were claiming that the central banks of the world were fighting the downturn differently from how things were handled in previous crises?

Note well, I’m speaking here in absolute terms, not in a Sumnerian view whereby the Fed–by definition–has been ‘tight’ the last few years because NGDP is below trend. Rather, I’m asking (for example) if it’s true that central banks in the early 1930s were actively trying to ease credit (by lowering interest rates, setting up special asset purchases or loan programs, etc.) when they had never done things like this in earlier crises?”

First the issue of Lionel Robbins.

Here is what Lionel Robbins said:

“Now in the pre-war [viz. pre-WWI – LK] business depression a very clear policy had been developed to deal with this situation. The maxim adopted by central banks for dealing with financial crises was to discount freely on good security, but to keep the rate of discount high.

Similarly in dealing with the wider dislocations of commodity prices and production no attempt was made to bring about artificially easy conditions. The results of this were simple. Firms whose position was fundamentally sound obtained what was necessary. Having confidence in the future, they were prepared to foot the bill. But the firms whose position was fundamentally unsound realised that the game was up and went into liquidation. After a short period of distress the stage was once more set for business recovery.

In the present depression we have changed all that. We eschew the sharp purge. We prefer the lingering disease. Everywhere, in the money market, in the commodity markets and in the broad field of company finance and public indebtedness, the efforts of Central Banks and Governments have been directed to propping up bad business positions.

We can see this most vividly in the sphere of Central Banking policy. The moment the boom broke in 1929, the Central Banks of the world, acting obviously in concert, set to work to create a condition of easy money, quite out of relation to the general conditions of the money market. This policy was backed up by vigorous purchases of securities in the open market in the United States of America. From October 1929 to December 1930 no less than $410 millions was pumped into the market in this way. The result was as might have been expected. The process of liquidation was arrested. New loans were floated.” (Robbins 1935: 72–73).

Robbins asserts that the pre-WWI central bank policy had been to keep discount rates high and only “discount freely on good security.”

He then asserts that in the 1929–1933 contraction “we have changed all that.” Yet Robbins is wrong, certainly with respect to the United States.

For the Federal Reserve banks had regularly lowered rates and engaged in substantial bond buying programs to fight the 1920s recessions before 1929. The Fed cut rates in 1921, 1924 and 1926–1927 to fight recessions, and cut rates and bought bonds in 1924 and 1926–1927.

Here is a list of 1920s recessions:

1920s Recessions
Recession | Duration Months
January 1920–July 1921 | 18
May 1923–July 1924 | 14
October 1926–November 1927 | 13.

http://www.nber.org/cycles.html

Let us look at the policy responses of the Fed to the 1920s recessions:

(1) 1920–1921 Recession

Here are the Fed cuts to the discount rate during the recession of 1920-1921:

Discount Rate of the Federal Reserve Bank of New York
Date | Rate
1920
May | 6%
June | 7%
Dec. | 7%
1921
Jan. | 7%
Apr. | 7%
May. | 6.5%
Jun. | 6%
Jul. | 5.5%
Sep. | 5%
Nov. | 4.5%

1922
Jan. | 4.5%
Jun. | 4%.
http://fraser.stlouisfed.org/download-page/page.pdf?pid=38&id=1477

Although the rate was raised to 7% in June 1920, the rate was cut from 7% in 1921 to 5.5% by July, and a further cut to 5% in September as the recovery had begun, and then to 4.5% in November.

(2) 1923–1924 Recession

Let us start with bond purchases:

Bond Purchases
Date | Fed government security holdings
1923
Apr. | $229
July | $97
Oct. | $91

1924
Jan. | $118
Apr. | $274
Jul. | $467
Oct. | $585

1925
Jan. | $464.
(Wheelock 1992: 22).

By early 1924, the Federal reserve banks began a bond buying program. Federal Reserve holdings increased from $91 million in October 1923 to $585 million by October 1924. That was increase of $494 million over about a year. In other words, a six-fold increase in the course of a year.

By April 1924, the Fed bought $156 million in bonds in the period from January, and by July 1924 had bought about another $193 in bonds to fight the recession.

Next, the discount rate:

Discount Rate of the Federal Reserve Bank of New York
Date | Rate
1923
Apr. | 4.5%
Jul. | 4.5%
Oct. | 4.5%
1924
Jan. | 4.5%
Apr. | 4.5%
Jul. | 3.5%
Oct. | 3.0%
1925
Jan. | 3.0%.
(Wheelock 1992: 22).

In 1924, the rate was brought down from 4.5% to 3% – a reasonable cut.

So here we have quite clear evidence that the Fed fought the 1923–1924 recession with both discount rate cuts and a bond buying program. The bond buying program, in particular, was large and comparable to that done by the Fed between late 1929 and 1930.

(3) 1926–1927 Recession

First, the bond purchases:

Bond Purchases
Date | Fed government security holdings
1926
Oct. | $306
1927
Jan. | $310
Apr. | $341
Jul. | $381
Oct. | $506
1928
Jan. | $512.
(Wheelock 1992: 22).

From October 1926 to October 1927, the Fed increased its government security holdings by $200 million.

Next, the discount rate:

Discount Rate of the Federal Reserve Bank of New York
Date | Rate
1926
Oct. | 4.0%
1927
Jan. | 4.0%
Apr. | 4.0%
Jul. | 4.0%
Oct. | 3.5%
1928
Jan. | 3.5%.
(Wheelock 1992: 22).

Here the discount rate cut was not very large, but bond buying program was hardly insignificant.

Again, both rate cuts and asset purchasing were the norm.

When we come to 1929–1933, we can see that monetary policy actions were not “qualitatively different” (the expression Murphy uses here in this comment) from previous policy – they differed merely in quantity, not quality: lower rate cuts and some more bond purchases than previously.

Let us look at the bond buying program:

Bond Purchases
Date | Fed government security holdings
1929
Jul. | $147
Oct. | $154
1930
Jan. | $485
Apr. | $530
Jul. | $583
Oct. | $602
1931
Jan. | $647
Apr. | $600
Jul. | $674
Oct. | $733.
(Wheelock 1992: 22).

Far from being unprecedented, the similar program from 1923–1924 provides a good precedent.

From July 1929 to late 1931, Fed holdings of treasuries increased about fivefold, and this was in a period of over two years.

Yet in the year from 1923-1924, Federal Reserve holdings increased from $91 million in October 1923 to $585 million by October 1924. That was a six-fold increase over about a year, much more radical than the 1929-1931 program and in a shorter time too!

Next the discount rate:

Discount Rate of the Federal Reserve Bank of New York
Date | Rate
1929
Jul. | 5.0%
Oct. | 6.0%
1930
Jan. | 4.5%
Apr. | 3.5%
Jul. | 2.5%
Oct. | 2.5%
1931
Jan. | 2.0%
Apr. | 2.0%
Jul. | 1.5%
Oct. | 3.5%. (Wheelock 1992: 22).

Here the discount rate was quite high in late 1929, but the cuts were certainly sharper than in previous recessions.

The rate came down to 1.5% by July 1931. This was a low rate, but we are dealing with quantity, not a qualitative difference, for the use of discount rate cuts had perfectly good precedents in 1924 and 1927.

We might also note that in 1931 the New York Fed raised the discount rate to 3.5% by October from 1.5%: right in the midst of the worst depression ever seen. Now, if anything, that was a “qualitatively different” policy measure from previous 1920s policy!

Conclusion
Murphy is dead wrong in thinking that the Fed policy in 1929–1933 “was a complete reversal of traditional central bank doctrine” – it was nothing but a development of already existing policy actions.

It is also utterly absurd to say that “central banks in the early 1930s were actively trying to ease credit (by lowering interest rates, setting up special asset purchases or loan programs, etc.) when they had never done things like this in earlier crises” – in the case of the Federal Reserve banks, they had done precisely these policy interventions from 1923–1924 and 1926–1927.

If it is any consolation to Murphy, I have now bought a copy of his book The Politically Incorrect Guide to the Great Depression and the New Deal...

BIBLIOGRAPHY

Murphy, Robert. 2009. The Politically Incorrect Guide to the Great Depression and the New Deal. Regnery Publishing, Inc. Washington, DC.

Robbins, Lionel Charles Robbins. 1935. The Great Depression. Macmillan, London.

Wheelock, David C. 1992. “Monetary Policy in the Great Depression: What the Fed Did, and Why,” Federal Reserve Bank of St. Louis Review 2: 3–27.
http://research.stlouisfed.org/publications/review/92/03/Depression_Mar_Apr1992.pdf

Another Austrian Fable

I refer to the last statement made by Robert P. Murphy at the end of this post:

Robert P. Murphy, “There’s Really Been a Lot of Real Shocks to the Economy,” 24 September, 2012.

Here is what he says:

“And–if I might be even bolder–maybe all of the crazy things FDR did under the New Deal explain the length of the Great Depression, as opposed to ‘tight money’ (even though the US went off gold in 1933, and we never had a depression as long under the gold standard as we did after we went off it).”

Notice how this statement depends on a loose definition of the word “depression” to include not just a period of real output collapse, but its aftermath. If we define “depression” as GDP contraction and its aftermath with high unemployment, then the 19th century had two serious “depressions”: the 1870s and 1890s, for example.

According to the data from Davis’s (2004) industrial index, the US had a recession from 1873 to 1875 lasting less than 3 years, but then an aftermath of continued, rising unemployment right down until 1878. The 1890s saw a double dip recession and rising unemployment until 1898. In one important respect, both these decades were worse than the Great Depression, because in the 1870s and 1890s unemployment continued to rise even after a recovery began. By contrast, at least unemployment started falling in 1933 (and subsequent years) when the recovery from the Great Depression occurred.

In economic literature, however, one will find a useful definition of “depression” as a contraction of 10% or more in the value of real output (or real GDP/GNP). Even the Economist informs us that there are “two principal criteria for distinguishing a depression from a recession: a decline in real GDP that exceeds 10%, or one that lasts more than three years.”

By this definition, America had a depression from 1929–1933. The depression – that is to say, the real output contraction – ended in 1933, and what followed was its aftermath: a period of high, but falling, unemployment and recovery, where there was real output growth.

And, by the same definition, it is patently absurd to blame Roosevelt for what happened from 1929 to March 1933 (when the actual depression occurred), since he was not even inaugurated until the later month and year.

It also equally absurd to invoke the gold standard. The US abandoned the gold standard in June 1933, and after this experienced a period of recovery. The US had the worst depression in its history while it was on a gold exchange standard.

What happened after Roosevelt was inaugurated and in the years when he turned to moderately expansionary fiscal policy? Both real GDP and real per capita GDP grew and expanded at quite high rates historically, as we can see here:

Year | GDP* | Growth Rate
1929 | $977,000
1930 | $892,800 | -8.61%
1931 | $834,900 | -6.48%
1932 | $725,800 | -13.06%
1933 | $716,400 | -1.29%
1934 | $794,400 | 10.88%
1935 | $865,000 | 8.88%
1936 | $977,900 | 13.05%
1937 | $1,028,000 | 5.12%
1938 | $992,600 | -3.44%
1939 | $1,072,800 | 8.07%
1940 | $1,166,900 | 8.77%
* Millions of 2005 dollars
http://www.measuringworth.com/datasets/usgdp/result.php

Next, real per capita GDP:

Real US Per Capita GDP 1870–2001
(in 1990 international Geary-Khamis dollars)
Year | GDP | Growth rate
1929 | 6899 | 5.02%
1930 | 6213 | -9.94%
1931 | 5691 | -8.40%
1932 | 4908 | -13.75%
1933 | 4777 | -2.66%
1934 | 5114 | 7.05%
1935 | 5467 | 6.90%
1936 | 6204 | 13.48%
1937 | 6430 | 3.64%
1938 | 6126 | -4.72%
1939 | 6561 | 7.10%
1940 | 7010 | 6.84%
(Maddison 2006: 88).

By 1936, real GDP had surpassed its 1929 level, and in 1937 real per capita GDP was close to reaching its 1929 level as well – until Roosevelt listened to advocates of fiscal austerity and the economy plunged back into recession.

And unemployment under Roosevelt fell consistently down to 1938. It is now well known that the official statistics do not include the employment provided by emergency and relief work in US federal government programs (Darby 1976). The reason for this was nothing but an ideological bias on the part of Lebergott, who compiled the figures.

When employment provided by relief work is included in the employment figures, unemployment under Roosevelt came down from 25% to just under 10% by 1937. This is a much better record on unemployment than the official statistics reveal.

One can see proper graphs of the falls in unemployment here:

Mitchell, B., “What causes mass unemployment?,” January 11th, 2010.

“(Very) short reading list: unemployment in the 1930s,” October 10, 2008.

The unemployment rate soared again when Roosevelt cut government spending in 1937, but the adjusted figures show it rising from under 10% to about 12.5% in 1938, and not to around 19% in the old figures

The Austrians just flunk history, time and again.


BIBLIOGRAPHY

Darby, M. R. 1976. “Three-and-a-Half Million U.S. Employees Have Been Mislaid: Or, an Explanation of Unemployment, 1934–1941,” Journal of Political Economy 84.1: 1–16.

Davis, Joseph H. 2004. “An Annual Index of U. S. Industrial Production, 1790–1915,” The Quarterly Journal of Economics 119.4: 1177–1215.

Davis, Joseph H. 2006. “An Improved Annual Chronology of U.S. Business Cycles since the 1790s,” Journal of Economic History 66.1: 103–121.

Lebergott, S. 1964. Manpower in Economic Growth: The American Record since 1800. McGraw-Hill, New York.

Maddison, Angus. 2003. The World Economy: Historical Statistics. OECD Publishing, Paris.

Robert P. Murphy Gets it Wrong on Stimulus in Sweden and the US

Robert P. Murphy has a post here criticising a comment of mine on fiscal policy in Sweden (as compared with the US):

Robert P. Murphy, “Lord Keynes Beautifully Illustrates Why We Get Nowhere in the Stimulus Debate,” Free Advice, 21 May.

Unfortunately, his response is flawed:

(1) the links I cited were to demonstrate that Sweden implemented a stimulus from 2008, not what Murphy says.

The first remarks of Murphy’s post are therefore of no value: it is only Murphy’s erroneous assumption that is at fault here. Murphy assumed, falsely, that my links were meant to prove this idea: “that Sweden is running a budget surplus now is a demonstration that their stimulus worked.” In fact, they were there to prove my assertion that Sweden “passed a large stimulus package in 2008, which continued in 2009 and 2010.” Does Murphy deny this?

Nor did I deny that “the US under any plausible metric ran a bigger Keynesian stimulus than Sweden” – of course it did. That is not the point.

The inference that Sweden’s stimulus worked is my inference, easily confirmed by the fact that

(i) the Swedish stimulus has resulted in real output growth in 2009, 2010, and most of 2011 (which, of course, the links confirm; see here as well) and
(ii) rising tax revenues.

Does Murphy deny either of these two facts?

(2) The whole assumption underlying Murphy’s comparison of the size of the stimulus in Sweden and the US is flawed for the following simple reason: what kind of naive or ignorant person believes that the global recession of 2008-2009 was exactly of the same scale, depth and magnitude in all nations?

What kind of naive person believes that the financial crisis and resulting debt deflationary effects were exactly the same in all countries? Or that the asset bubbles and private debt levels (and resulting private sector deleveraging effects and knock-on effects on the real economy) were all the same?

This is a nonsensical assumption: different countries had different economic conditions, and different crises; consequently, there is no reason why different levels of stimulus will have worked in some nations and not in others. Or why a stimulus of a certain level in Sweden was appropriate there, but not in America. Or why America’s stimulus, even though it was larger than Sweden’s, had different effects too (e.g., not as great an affect on employment).

America had a financial crisis and credit contraction of much greater severity than Sweden. America’s housing bubble and private debt levels are much higher than Sweden’s.

(3) Murphy shows himself incompetent in even understanding basic elements of Keynesian economics. He asserts:

“First let’s consider the deficit as a % of GDP, which is how Keynesians typically evaluate stimulus in the 1930s.”

Um, no, they don’t, Murphy – at least not serious Keynesian economists. How Keynesians “evaluate stimulus in the 1930s” will be find in E. Cary Brown, 1956. “Fiscal Policy in the ’Thirties: A Reappraisal” (American Economic Review 46.5: 857–879): it does not evaluate stimulus in terms of some crude citation of deficits. There is a reason why. It is not the size of a budget deficit per se that will show you if a budget is expansionary or contractionary in terms of fiscal effects. It is perfectly possible to have a budget deficit and have contractionary fiscal policy (as in Ireland and Greece today).

In order to stimulate an economy back to its growth path and potential GDP, one has to do the following:

(i) calculate potential GDP and estimate how severely GDP is likely to collapse by,
(ii) estimate the Keynesian multiplier and
(iii) then design fiscal policy to expand demand by tax cuts and/or appropriate level of discretionary spending increases to hit potential GDP via the multiplier.

A great deal of any budget deficit during a recession is merely the result of maintaining spending because of tax revenue collapse.

In both theory and practice, you could have a budget deficit, yet impart zero stimulus to an economy. You can even contract an economy and run a deficit. It beggars belief that a person like Murphy, who sets himself up as some great critic of Keynesianism, appears ignorant of this.

One will need to look at the overall expansionary effect of a budget in terms of its addition to aggregate demand, the most important part of which is how high increases in discretionary spending were.

Sweden and the US both had different recessions. The US had a severe financial crisis. Sweden had no serious financial crisis (see under the heading “Do we have a financial crisis in Sweden?”). America had a huge housing bubble; in Sweden there has been a much smaller real estate bubble and it has not yet burst. Develeraging and debt deflationary effects in America and Sweden have been different. The state of the private sector in both countries is different.

Comparing the size of budget deficits in Sweden and the US does not even show us comparable data for the size of the stimulus in each nation. As a matter of fact, the US stimulus was about 2% of GDP in both 2009 and in 2010. Sweden was much smaller: additional fiscal spending was about 0.38% of GDP (David Saha and Jakob von Weizsäcker, “Estimating the size of the European stimulus packages for 2009,” 20th, February 2009, p. 17).

But then Sweden’s financial sector was not crippled, nor was its private sector in such a bad state as America’s in 2008, 2009 and 2010. It is not surprising that a differently-sized stimulus to that in America worked well in Sweden’s case.

(4) Murphy then cites the overall size of government spending in the economies of Sweden and US, and comes to conclusions so bizarre it so difficult to take him seriously. Here are his data:

Swedish Gov’t Spending as % of GDP
2007: 51.0%
2008: 51.7%
2009: 55.2%
2010: 53.0%

US Federal Gov’t Spending as % of GDP
2007: 19.7%
2008: 20.8%
2009: 25.2%
2010: 24.1%

The fact that Sweden has government spending of over 50% means that its economy was already cushioned from private sector shocks and falls in real output in the 2000s long before the great recession, and certainly to a far greater extent than an economy where it is on the order of 20-25% (like the US).

Sweden’s recovery is thus partly a function of the high degree of government spending (G) in its GDP already in 2008 when its recession struck.

Nor is the particular degree to which government spending rose in each country relevant here: for the US and Sweden experienced different types of recession and thus the degree of stimulus necessary was different in each case (horses for courses, so to speak).

(5) And what is this?:

“Since Sweden handled the crisis much better than the US did, I would say the case of Sweden is prima facie evidence for the Austrian / austerian camp. As always in these matters, these particular data don’t prove anything; maybe there are confounding factors.”

What!? A nation that got out of recession after implementing a stimulus, and where government spending was 51.7% of its GDP in 2008, which then increased to 55.2% in 2009, is “prima facie evidence for the Austrian ... camp.”

Then the whole thing collapses with the words “these particular data don’t prove anything.” What? So what was the point of citing them?

Finally, some questions for Murphy:

(1) Do you dispute that Sweden implemented a stimulus, with expansionary fiscal policy in 2009 and 2010?

(2) Do you dispute that the Swedish recession ended about the middle of 2009 after this stimulus was implemented, and real output growth resumed? If “yes,” then what in your view caused the end of the recession and real output growth that Sweden has had subsequently? Magic?

(3) Do you dispute that the Swedish recovery led to rising tax revenues? That the budget deficit fell?

BIBLIOGRAPHY

Cary Brown, E. 1956. “Fiscal Policy in the 'Thirties: A Reappraisal,” American Economic Review 46.5: 857–879.

Robert P. Murphy on the Sraffa-Hayek Debate

Robert P. Murphy has posted this paper on this blog:

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.

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).

Murphy then discusses Lachmann’s (1994: 154) solution to Sraffa’s critique, but finds it wanting:

“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.”
(Murphy, “Multiple Interest Rates and Austrian Business Cycle Theory,” pp. 14).

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.

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.”
(Robert P. Murphy, “Multiple Interest Rates and Austrian Business Cycle Theory,” p. 23).

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:

(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.

(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.

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.


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.”

Robert P. Murphy on the Pure Time Preference Theory of the Interest Rate

The Austrian scholar Robert P. Murphy has made his PhD thesis available on his blog:

Robert P. Murphy, “Is Keynes from Heaven or Hell,” 7 July 2011.

The PhD is a study with three separate essays dealing with Austrian capital and interest rate theory. In the second essay, Murphy critiques the pure time preference theory of the interest rate (Murphy 2003: 58–126), and, in his third chapter, he supports a view of interest rates as purely monetary phenomena (Murphy 2003: 127–177).

In taking a monetary theory of the interest rate, Murphy is far closer to Keynes than the views of many of his fellow Austrians, and indeed in his blog post above he cites Keynes’ remarks on interest in Chapter 13 of the General Theory with measured approval (Robert P. Murphy, “Is Keynes from Heaven or Hell,” 7 July 2011).

Murphy’s PhD is also worth reading in its own right. Some highlights follow.

On p. 107 (n. 33), Murphy identifies some hypocrisy from Henry Hazlitt, who had condemned Keynes’s concept of “own rates of interest” as a “strange” idea and “nonsense,” even though Rothbard uses a similar concept in his analysis of interest in capital goods markets. Murphy contends that the pure time preference theory of interest rates “encourages exactly the type of thinking that Hazlitt finds so absurd” (Murphy 2003: 107, n. 33).

From pp. 100–107, one can read Murphy’s critique of the idea that a uniform rate of originary interest would arise amongst all individuals and in goods markets.

It is only in the imaginary “evenly rotating economy” (ERE), a stationary general equilibrium with “a world of certainty and unchanging conditions over time” (Murphy 2003: 103), that a uniform rate of originary interest would emerge. In a dynamic general equilibrium the uniform rate need not emerge.

Here Murphy invokes the Hayek–Sraffa exchange, and Ludwig Lachmann’s possible solution to the problem of the unique natural rate:

“What is much less clear to us is to what extent Hayek was aware that by admitting that there might be no single rate he was making a fatal concession to his opponent. If there is a multitude of commodity rates, it is evidently possible for the money rate of interest to be lower than some but higher than others. What, then, becomes of monetary equilibrium?” (Lachmann 1994: 154).

“It is not difficult, however, to close this particular breach in the Austrian rampart. In a barter economy with free competition commodity arbitrage would tend to establish an overall equilibrium rate of interest. Otherwise, if the wheat rate were the highest and the barley rate the lowest of interest rates, it would be profitable to borrow in barley and lend in wheat. Inter-market arbitrage will tend to establish an overall equilibrium in the loan market such that, in terms of a third commodity serving as numéraire, say steel, it is no more profitable to lend in wheat than in barley. This does not mean that actual own-rates must all be equal, but that their disparities are exactly offset by disparities between forward prices. The case is exactly parallel to the way in which international arbitrage produces equilibrium in the international money market, where differences in local interest rates are offset by disparities in forward rates” (Lachmann 1994: 154).

Murphy rejects Lachmann solution:

“Lachmann is defending Hayek from Sraffa’s claim that there is no reason for a unique ‘natural rate of interest.’ But Sraffa’s whole point was that there are, in principle, just as many natural rates as commodities; the fact that the rates in terms of any one commodity, such as steel, must be equal does not rescue Hayek. (One cannot explain the trade cycle as a deviation of the money rate of interest from ‘the’ natural rate of interest if the rate calculated in terms of steel is different from the natural rate calculated in terms of copper.) … arbitraging alone will not establish a unique real rate of interest in the way Lachmann seems to think.” (Murphy 2003: 102, n. 27).

According to Murphy, arbitrage would not lead to equalization of natural rates. As far as I can see, Murphy does not explore the consequences of this for the Hayekian versions of the Austrian trade cycle theory: if there is no unique natural rate of interest or tendency for such a unique rate, what becomes of the theory? This was the point of Sraffa’s critique of Hayek’s Prices and Production (Sraffa 1932a and 1932b).

Murphy concludes that interest is “quite simply the price of borrowing money or (what is the same thing) the exchange rate of present versus future money units” (Murphy 2003: 176).


BIBLIOGRAPHY

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

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

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.