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.

Mises’s “Originary Interest Rate” Theory

Mises uses the Wicksellian natural interest rate in his earlier work on Austrian business cycle theory. But, by the time of Human Action (1949), Mises is employing an “originary interest rate” concept, and talk of the natural rate largely disappears. Mises explains the theory:

“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 1998: 523).

This means that the originary interest is a future discounted good exchanging for a present good of higher value.

In terms of capital goods, this presumably means the discounted value of future goods against present goods that are borrowed now for capital goods investment.

But this is really just another real theory of the interest rate where loans are imagined as occurring in natura, or in real commodities in an economy at full employment. Mises is still subject to Sraffa’s critique of Hayek.

Curiosuly, when we turn to Roger Garrison we find the explicit use of the Wicksellian natural rate, as in Hayek’s work:

“So named by Swedish economist Knut Wicksell, the natural rate of interest is the rate that reflects the underlying real factors. In macroeconomic terms as applied to a wholly private economy, it is the rate that governs the allocation of resources between current consumption and investment for the future. By keeping saving and investment in balance, the natural rate guides the economy along a sustainable growth path. That is, governed by the natural rate, unconsumed current output (real saving) is used for augmenting the economy’s productive capacity in ways that are consistent with people’s willingness to postpone consumption. In the hands of the Austrian economists, the natural rate became the rate that reflects the time preferences of market participants and allocates resources among the temporally defined stages of production. The output of one stage serves as input to the next in this logical and broadly descriptive representation of the economy’s production process. The temporal dimension of the economy's capital structure is a key macroeconomic variable in Austrian theory. .... In summary terms, the natural rate is seen as an equilibrating rate. It is the rate that tells the truth about the availability of resources for meeting present and future consumer demands, allowing production plans to be kept in line with the preferred pattern of consumption. By implication, an unnatural, or artificial, rate of interest is a rate that reflects some extra-market influence and that creates a disconnection between intertemporal consumption preferences and intertemporal production plans” (Garrison 2006: 58–59).

So Garrison is also subject to same critique as Hayek. Yet in Garrison’s book Time and Money: The Macroeconomics of Capital Structure (London and New York, 2000), the word “Sraffa” does not (as far as I can see) even appear. It’s as if the Hayek–Sraffa exchange never occurred.


BIBLIOGRAPHY

Garrison, R. W. 2000. Time and Money: The Macroeconomics of Capital Structure, Routledge, London and New York.

Garrison, R. W. 2006. “Natural and Neutral Rates of Interest in Theory and Policy Formulation,” Quarterly Journal of Austrian Economics 9.4: 57–68.

Garrison, Roger W. 2007. “Natural and Neutral Rates of Interest in Theory and Policy Formulation,” Mises Daily, April 21
http://mises.org/daily/2513

Mises, L. 1998. Human Action: A Treatise on Economics, Mises Institute, Auburn, Ala.