ABCT without a Unique Natural Rate of Interest?

Well, this would be an improvement on that absurd theory, if it were possible.

A commentator on the last post complains that the Austrian business cycle theory (ABCT) – don’t you know?! – doesn’t even need a unique natural rate of interest / equilibrium rate of interest, despite the fact that every exposition of the theory I have seen relies on exactly that concept.

One can see this in Hayek’s Prices and Production:

“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; if they raise the money rate above the equilibrium rate—a case of less practical importance—they exert a depressing influence on prices.” (Hayek 2008 [1931]: 215).

One should note that emphasis on a single “equilibrium” or “natural” rate here. Roger Garrison, the leading modern exponent of ABCT, uses the same concept called a market-clearing or equilibrium rate:

“The supply and demand for loanable funds … identify a market-clearing, or equilibrium, rate of interest ..., at which saving (S) and investment (I) are brought into equality.” (Garrison 2000: 39).

On that same page in Time and Money: The Macroeconomics of Capital Structure (2000), Garrison makes it clear that this rate is essentially the Wicksellian rate causing intertemporal equilibrium.

So where are the Austrian scholars expounding their trade cycle theory with Sraffa’s multiple natural rates? The only work I have ever seen that could be seen as an improvement on the standard Austrian theory is that of Robert Murphy in this paper:

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

Commenting on the Hayek–Sraffa exchange in 1932, Murphy points out the following:

“In his brief remarks [sc. in reply to Sraffa], 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, to his credit, has pinpointed a very severe problem with modern ABCT (and I suppose it’s not a surprise to readers if I say he’s become one of favourite Austrians, not least of all because he supports a monetary theory of the interest rate).

Murphy denies the existence of a unique natural rate, but he has yet to produce any work showing how ABCT actually works with its non-existence. On pp. 19–23 of his discussion of the subject in a very 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,” 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. He’s done no such research as yet. Nor has any other Austrian.

BIBLIOGRAPHY

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

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.

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

Hayek and Equilibrium as a Starting Point for an Austrian Trade Cycle

As I pointed out in the last post, Hayek’s views on equilibrium changed in the course of his life. But in his early 1930s work on trade cycle theory he clearly assumed a state of equilibrium as a real world initial position in an economy subject to an Austrian trade cycle. I say this because a commentator on the last post persists in denying what is perfectly obvious. Readers who read the comments on that post will find a useful example of the irrational, obstinate and ridiculous fervour of “internet” Austrians, attempting to deny basic facts.

Hayek’s assumption of a real world full employment equilibrium state is confirmed in a letter that Hayek wrote to John Hicks in 1967, regarding the assumptions of his theory, where Hayek confirms that his theory required equilibrium and full employment as the initial stage at the beginning of the process leading to the trade cycle:

Hicks to Hayek, November 27, 1967“... We have (a) full employment, (b) static expectations, (c) ‘equilibrium’ at every stage, so that demand = supply in every market, prices being determined by current demand and supply. Add to these the Wicksell assumption, of a pure credit economy and we clearly find that if there were no lags, the market rate of interest cannot be reduced below the natural rate in an equilibrium position; ....

Hayek to Hicks, December 2, 1967

I accept assumption (a), full employment. I am not sure that I quite know what (b) ‘static expectations’ means, but if it means that at each stage of the process everybody acts in the expectation that future prices will be the same as present prices, I accept that too – though we shall see that these expectations must be disappointed.

Of (c) I can accept that at each stage in every separate market demand = supply in the sense that at the ruling price all buyers and sellers buy and sell as much as they want to buy at that market, but not in the sense that any change in the supply which a change in price will bring about in the course of time has already taken place or that prices correspond to the marginal costs at which producers now begin to produce.

Nor need there [be] at any but the initial stage an overall equilibrium between the different markets, because a change of price necessary to secure equality between demand and supply in any one market will make at the next stage a change of other prices inevitable as a result of the changed receipts in the first market being spent.

Let us now start with a system in full stationary equilibrium: constant prices and no net saving or investment and no changes in the supply of factors or tastes and a constant flow of money (which may be a token or partly credit money) ... (Hayek 1999: 100–102).

Moreover, Hayek, on pages 265–266 of Prices and Production, explicitly tells us his purpose in the book:

“My present task is to fill in the details of that rough sketch and to show what happens in the interval before a new equilibrium is attained.” (Hayek 2008: 265–266).

If Hayek thought at this stage in his career that equilibrium states can never occur in the real world, then what was point of his trade cycle theory?

BIBLIOGRAPHY
Hayek, F. A. von, 1999. Collected Works of F.A. Hayek, Volume 6: Good Money, Part II: The Standard, Routledge, London.

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.