Monday, July 11, 2011

Bob Wenzel on Bob Murphy on Liquidity Preference

Bob Wenzel criticizes Bob Murphy for drawing an objective conclusion regardless of the ideological fallout that it might inspire (which is absolutely not to say that everyone who took issue with Bob Murphy was being ideological about it... but you could sense him bracing himself in the original post).

I left this response on Wenzel's blog - nothing revolutionary, but hopefully helpful:

"You seem to be confusing "liquidity" with "cash in your wallet". Liquidity for Keynes is simply the control over funds to use as a medium of exchange.

You can save $1,000 in your mattress for ten years, you can save $1,000 in a savings account for ten years, you can save $1,000 in a 2 year CD for ten years (rolling it over four times), you can save $1,000 in a 5 year CD for ten years (rolling it over once), or you can save $1,000 in a 10 year CD for ten years.

In each case your time preference is to forgo $1,000 in the present and use it ten years from now. However, your liquidity preference varies in each case.

Holding time preference constant, we still have a variance in the interest rate that people are willing to accept.

That's the liquidity preference theory of interest. That's all it is. It shouldn't be all that controversial. People should be able to identify this in their own lives - think about how much you keep in a savings account vs. how much you tie up in other accounts. Usually it's not because the amount you keep in savings is expected to be used any more imminently than what you keep in a CD or something else. Sometimes people have a specific imminent purchase in mind, but often it's intended to sit and earn interest for the same amount of time. You just trade off the interest rate against how accessible you want those funds. If you need less accessibility you tie it up in a higher interest rate account for the exact same time span that you're expecting to leave the money in savings. It's precisely the uncertainty of those expectations that causes us to keep money liquid. If we were certain, we'd put it all in a high interest account for precisely the time period that is consistent with our time preference
."

One of the things that bothers me about the way people talk about liquidity preference is when they refer to it as "hoarding". Hoarding implies that mattress-stuffing caused the Great Depression. This is silly, of course. Certain sorts of money holding can be more liquid than others, and so an increase in liquidity preference can shift the composition of money holdings to be relatively more liquid across the board without a discernable increase in cash holdings.

I think it's also fair to give Bob Murphy a voice here. This is his comment on Wenzel's post:

"I was going to make a Darth Vader joke, but this is actually an important issue and I'm amused at how many people are high-fiving Wenzel here, when he is the one who is clearly using a weird, non-layman's definition of "saving."

15-year-old Johnny mows my lawn every week, and I pay him $20 each time. Every week, he spends $15 of it going to the movies with his friends, but he puts $5 in a piggy jar on his bureau.

After a year, he has accumulated $5x52 = $260 which he uses to buy a nice watch. Johnny says, "I'm sure glad I consumed less than my income all year, saving $5 per week. Then I used my accumulated savings to buy a watch. I deferred consumption all year in order to buy a nice good later on."

Wenzel says, "What the heck are you talking about? Are you a Keynesian Johnny? You haven't saved at all."

Are you guys all comfortable with that? You don't think Johnny was saving $5 per week?
"

37 comments:

  1. I think I'm finally beginning to understand your theory (or the Keynesian theory) of the interest rate.

    Correct me if I'm wrong - but I believe it depends on fractional reserve banking to appear.

    In a 100% reserve banking system (let's say, a gold standard) - savings accounts would be totally illiquid - and in fact, anything except keeping money in cash (or instant demand deposits) would be illiquid. They're just investments at that point, governed by time preference. It's only looseness of money between accounts that fractional reserve banking provides that allows for liquidity to play a role in interest rates.

    Because it seems that Keynes himself, at least in 1936, held to a certain loanable funds theory in describing volume of savings and investment.

    Or am I just going off the deep end?

    ReplyDelete
  2. Hazlitt, on Keynes' liquidity preference theory, offering some support for my idea:

    "3. Interest Is Not Purely Monetary

    The reader will notice that in the paragraphs above I have frequently substituted the term "cash preference" for Keynes's "liquidity-preference." I do not think that either term is helpful or necessary; they throw considerably more confusion, and considerably less light, on the condition to be analyzed than the traditional terms that Keynes rejects. But as between the two, cash preference is much to be preferred to liquidity-preference, not only because it is less vague, but because it does not, like liquidity-preference, make Keynes's doctrine self-contradictory. For if a man is
    holding his funds in the form of time-deposits or short-term Treasury bills, he is being paid interest on them; therefore he is getting interest and "liquidity" too. What becomes,
    then, of Keynes's theory that interest is the "reward" for "parting with liquidity"?

    One can only earn interest on demand deposits in an environment of fractional reserve banking. Demand deposits in a 100% reserve environment would be tantamount to Rothbard's idea of "warehouse receipts."

    Hazlitt continues:

    "Even if a man carries his liquid funds, not in the form of cash under the mattress, but in the form of a demand bank deposit, the bank is lending out, say, some four-fifths of this, and therefore in combination they are getting the better of both worlds. For he still has the "liquidity" and the bank has the interest."

    What are your thoughts?

    ReplyDelete
  3. This is starting a whole new project for me - elucidation of interest rate theories.

    I'm going to take a look into (when I get some money):

    Ludwig von Mises, Theory of Money and Credit
    Irving Fisher, The Theory of Interest
    Frank Knight, The Ethics of Competition and Other Essays
    Eugen von Bohm-Bawerk, Capital and Interest
    Knut Wicksell, Interest and Prices

    Care to offer any suggestions?

    ReplyDelete
  4. I don't know about the link between fractional reserve and liquidity preference. That sounds reasonable enough. In 100% reserves interest is really just a fee for using a given amount of money, right?

    Although I'm not so sure - you can still stuff mattresses in a 100% reserve banking system, after all (even if there's not as much diversity or freedom of choice in banking accounts). If 90% of the money is stuffed in mattresses that's going to limit what is supplied in banks which would raise the "fee" for lending money. That sounds like a liquidity preference theory of the interest rate.

    ReplyDelete
  5. Hazlitt seems to be wrong for precisely the reason I pointed out Wenzel was wrong.

    ReplyDelete
  6. @ Mattheus,

    You don't need that much money. Mises, Bawerk and Wicksell you get at Mises.org. From Fisher they only have "The Rate of Interest: Its Nature, Determination, and Relation to Economic Phenomena" And from Frank Knight "Risk, Uncertainty, and Profit"

    But Fishers "Theory of Interest" you get at EconLib.org.

    The only thing I would suggest is to have an E-book reader which manages pdf files well.

    ReplyDelete
  7. re: "Irving Fisher, The Theory of Interest"

    You might be interested in adding "Appreciation and Interest" (1896), by Fisher, to your list. This is a short book that I want to better familiarize myself with. Fisher gets close to a liquidity preference theory of the interest rate, forty years before Keynes. Unfortunately, he moved on from it. We could have had the Keynesian revolution before the Great Depression - Keynes would have been a Fisherian (as would Samuelson), and policy perhaps would have been much better during the Great Depression.

    ReplyDelete
  8. @ Daniel

    "Certain sorts of money holding can be more liquid than others, and so an increase in liquidity preference can shift the composition of money holdings to be relatively more liquid across the board without a discernable increase in cash holdings."

    This would mean that before a recession happens a considerable shift of savings into more liquid forms must happen, which then starts the recession. So there should be evidence that in 2006 and 2007 such a shift must have happened. Is there any data that shows this?

    ReplyDelete
  9. If you hold a current account balance with a fractional reserve bank that entitles you (in most cases) to free banking services. Free direct debits, cheque clearing and other sorts of money transfer for example. So, even for an on-demand account you are paid interest, it's simply not in the form of money, but in services.

    In Britain for many years even many chequing accounts paid interest, though I understand since the crisis few do. The only reason this didn't happen in the states was that it was prohibited by regulation Q.

    So the idea that zero interest and liquidity form some special union is wrong.

    ReplyDelete
  10. Current -
    re: "So the idea that zero interest and liquidity form some special union is wrong."

    Right. I don't know who this was directed at but I hope no one was under the impression that I think this. It is true at the extreme end of liquidity preference: mattress stuffing doesn't earn you interest. But this is precisely my critique of Wenzel and (now that Mattheus brings him up) Hazlitt. You have to recognize that there is a trade-off with liquidity. Liquidity isn't an on/off switch. All sorts of financial products and services offer at least some measure of liquidity.

    skylien -
    Well the most obvious example is the move to Treasuries. But I don't have the expertise to identify certian kinds of accounts and funds and partial this out.

    I'm curious why you date this back to 2006-2007. Maybe you'd see some in 2007, but I would have thought the flight to liquidity is what you'd see in the crash itself, not before the crash happens. In 2006 I'd expect to see precisely the opposite - liquidity preference is relatively low.

    There are other measures of liquidity, of course. Monetary velocity for example. That certainly fell off with the downturn.

    The Survey of Consumer Finances has some interesting questions on reasons for saving, and you can sort of identify liquidity preference from those questions. I looked at prior years and it was hard to pull out notable changes in liquidity preference. However, the 2009 SCF is out, and it's the second panel of the 2007 SCF. That would be interesting to see how specific families changed their reasons for saving from 2007 to 2009.

    ReplyDelete
  11. That sounds reasonable enough. In 100% reserves interest is really just a fee for using a given amount of money, right?

    There's a really big difference between a fee and the interest charged.

    One would pay a certain premium or fee to keep demand deposits in a bank - as you would pay a fee to keep something in a storage facility downtown; and one would earn interest on savings (more precisely, loanable funds) that was kept by banks. They would be precisely different functions, probably operated by different kind of banks.

    In one case, you have instant convertibility into cash - and in the other, you have maturing interest contracts that you cannot convert or redeem at par. One would earn interest from the bank after you loan money, because they lend it out and earn a higher rate of interest, and pay you close to the difference.

    One is governed purely by uncertainty, and the other purely time preference. The amount of immediately disposable cash and demand deposits is a directly related to the level of uncertainty man fears (so he speculates in holding money), whereas the amount of actually saved and lent capital is directly related to his consumption preferences - to consume more later than he does now. Fractional reserve banking policies muddle the clear distinction that we see with regards to a 100% reserve system, and so we might actually be paid "interest" (although it's not catalactically interest payments) for "liquidity!"

    ReplyDelete
  12. If 90% of the money is stuffed in mattresses that's going to limit what is supplied in banks which would raise the "fee" for lending money. That sounds like a liquidity preference theory of the interest rate.

    If 90% of the money is stuffed in mattresses, we're looking at a society that has absolutely no savings whatsoever - given that it needs to consume some meager amount. This kind of society would be exhibiting very high time preferences - in that they place value consuming more now versus later and a very high degree of uncertainty, whether politically, economically, or they fear a massive epidemic or some kind. The "fee" for lending money would, like the desire to save, be very low. If everyone is stashing 90% of their money income under the mattress, I doubt very much whether there'd be huge demand for roundabout investment opportunities.

    I don't see that as a liquidity preference example.

    Hazlitt seems to be wrong for precisely the reason I pointed out Wenzel was wrong.

    And I'm wondering if your argument as to why they are wrong is not a feature (or a bug) of modern fractional reserve banking policy; you're just showing that their economics doesn't match the details of our hampered market.

    The only thing I would suggest is to have an E-book reader which manages pdf files well.

    I know, but I want all of these as physical books. I'm weird like that.

    You might be interested in adding "Appreciation and Interest" (1896), by Fisher, to your list. This is a short book that I want to better familiarize myself with. Fisher gets close to a liquidity preference theory of the interest rate, forty years before Keynes.

    Okay, I'll add it. Maybe Fisher will be more convincing than Keynes.

    ReplyDelete
  13. You have to recognize that there is a trade-off with liquidity. Liquidity isn't an on/off switch. All sorts of financial products and services offer at least some measure of liquidity.

    Nobody denies that a person can hold assets in more or less liquid states. That's the best way of analyzing the uncertainty of the economy; by looking at how little they commit to long term investment and how much they feel the need to hold in immediately convertible cash or deposits.

    It seems to me, with your apt use of the word "fee" above, that you and I are not talking about the same phenomenon when we talk about interest. You are talking about a price that people pay for relinquishing liquidity, and I'm appealing to interest as a phenomena, present in all activities, individual and collective, that manifests itself on the time market.

    I don't really understand what kind of interest theory Keynes was really pushing! In rejecting time preference and productivity theories, he rejects all "real" factors of interest. The classical economists made the opposite mistake, and didn't account for monetary fluctuations in a complex society, but it seems to me that Keynes' purely liquidity preference theory is no theory at all, because it doesn't factor in time - which is, after all, what interest is all about.

    ReplyDelete
  14. re: "Nobody denies that a person can hold assets in more or less liquid states."

    I wish that were the case. Read the Wenzel post. Read your own Hazlitt quote!

    Lot's of people identify liquidity preference with cash-holding-preference. Hazlitt says this EXPLICITLY, Mattheus.

    But that's not the real world - all financial products have some degree of liquidity, and it varies across products. Cash is the most liquid, of course, but if you reduce liquidity preference to hoarding cash you're going to get poor analysis.

    re: "it seems to me that Keynes' purely liquidity preference theory is no theory at all, because it doesn't factor in time - which is, after all, what interest is all about."

    Huh?? Time is central in Keynes. What do you mean?

    ReplyDelete
  15. "Hazlitt says this EXPLICITLY, Mattheus."

    You're misunderstanding. He is really just refuting Keynes' argument that interest was "parting with liquidity" because in a demand deposit (or a CD as well), you are getting interest AND liquidity. That's his whole point. So he definitely sees that assets can be more or less liquid - this particular phrase has him saying, "Look! I can get interest on this deposit as well as having a liquid asset! How strange!"

    "Cash is the most liquid, of course, but if you reduce liquidity preference to hoarding cash you're going to get poor analysis."

    It seems like that's what you did in the above "90% money" case.

    "Huh?? Time is central in Keynes. What do you mean?"

    Keynes rejects, and in fact ridicules, all attempts to prove interest is determined by "real" factors. To him, it's just the reward (what a strange word to use) for giving up a certain amount of liquid assets. It's a purely monetary phenomenon (and he would presumably argue that interest does not exist in a barter economy).

    His understanding of interest does so without the measure of time. It's his marginal efficiency of capital by which expectations are channeled, not the interest rate.

    ReplyDelete
  16. re: "this particular phrase has him saying, "Look! I can get interest on this deposit as well as having a liquid asset! How strange!""

    What's so strange about that? Hazlitt has heard of this thing called the marginal revolution, hasn't he?

    What's so aggravating about Hazlitt is that Keynes is talking about liquidity. Hazlitt says "I'm going to act like Keynes is talking about cash when he says he's talking about liquidity and then disprove my own alteration of what Keynes said".

    Why is this man so revered?

    ReplyDelete
  17. And I'm well aware Keynes pulls this shit too.

    But you don't see me going around saying "if you want to read the definitive refutation of Jean Baptiste Say, you HAVE TO read the General Theory.

    I don't say that sort of thing. The whole Say's Law thing is good for framing Keynes's position but bad as a scholarly commentary on Say.

    People actually SAY THIS about Hazlitt all the time, and of all of Hazlitt's writings (I'm sure much of the economics is informative) you keep pointing me to this exceptionally bad treatment of liquidity preference for some reason.

    ReplyDelete
  18. Daniel,

    I agree with you in your reply to my comment above.

    I don't understand though why you are criticising Mattheus here. In the general theory Keynes wrote the following "...the mere definition of the rate of interest tells us in so many words that the rate of interest is the reward for parting with liquidity for a specified period". Hazlitt is simply criticising this.

    Your view is that we have a complicated situation where there are many different options of differing liquidity and interest payment. I agree with you and so does Mattheus. But, you are projecting this idea into the text that Keynes wrote, not reading from the text.

    Hazlitt is suggesting making a first-order break between preference for cash and preference for timed-savings as an alternative. I think we all agree that recognising that the situation is more complicated is preferable to that.

    ReplyDelete
  19. But Hazlitt is not criticizing this.

    Hazlitt is criticizing Keynes as if Keynes had said "the mere definition of the rate of interest tells us in so many words that the rate of interest is the reward for parting with cash for a specified period", which of course Keynes didn't say.

    ReplyDelete
  20. Which is fine to a certain extent - I agree with Hazlitt insofar as that is a weak statement of the argument for anyone that makes that argument.

    My point is only that Hazlitt does nothing to challenge a liquidity preference theory of the interest rate here.

    ReplyDelete
  21. "What's so strange about that?"

    What's strange about that is that Keynes explicitly defines the interest rate as the reward for parting with liquidity. Earning interest implies you don't have liquidity! And Hazlitt is showing that it's not that simple - we sometimes CAN have our cake and eat it too.

    "Hazlitt says "I'm going to act like Keynes is talking about cash when he says he's talking about liquidity and then disprove my own alteration of what Keynes said"."

    Keynes explicitly mentions liquidity. Hazlitt explicitly criticizes liquidity views. Where does cash come into this picture that I quoted (admittedly a bit out of context)?

    "Why is this man so revered?"

    Many of us could ask the same of Keynes.

    "People actually SAY THIS about Hazlitt all the time"

    Well, yeah. If you want the definitive refutation of mercantilism, you HAVE TO read the Wealth of Nation. If you want the definitive refutation of Godwin, you HAVE TO read Malthus. Likewise, Hazlitt set himself to refute Keynes entirely - not to reject him emotionally or indirectly as Keynes does to Say.

    "and of all of Hazlitt's writings (I'm sure much of the economics is informative) you keep pointing me to this exceptionally bad treatment of liquidity preference for some reason."

    Well, because this specific context shows Hazlitt saying something similar to what I said. It wasn't supposed to be a "gotcha" moment for me. Don't think that these "exceptionally bad treatments" are indicative of his work, or of y taste. I pulled it out of context because Hazlitt is foreshadowing my own thought on interest rates.

    "My point is only that Hazlitt does nothing to challenge a liquidity preference theory of the interest rate here."

    Is that an opinion on an out of context quote? Or of your own knowledge on Hazlitt's criticism?

    ReplyDelete
  22. re: "What's strange about that is that Keynes explicitly defines the interest rate as the reward for parting with liquidity. Earning interest implies you don't have liquidity!"

    Why does earning interest imply that you don't have liquidity, Mattheus?

    I earn a salary as a reward for parting with hours of my time. The fact that I earn a salary does not imply that I have no non-work time.

    Which is again why I ask - have you and Hazlitt never heard of the marginalist revolution???

    ReplyDelete
  23. re: "Where does cash come into this picture that I quoted (admittedly a bit out of context)?"

    You quoted Hazlitt saying: "The reader will notice that in the paragraphs above I have frequently substituted the term "cash preference" for Keynes's "liquidity-preference.""

    I am simply saying that if you want to criticize a cash-based theory, don't pretend you're criticizing a liquidity preference theory.

    When Hazlitt moves from talking about liquidity to talking about cash he makes it sound like Keynes is saying that you either have interest and no cash or no interest and cash. Either/or. Of course this is precisely why Keynes talked about liquidity and he talked about bonds of different maturity and the liquidity you expect to have at a future date etc. etc. Hazlitt basically throws that out the window and decides he doesn't want to have to deal with that by talking about cash-preference rather than liquidity preference.

    ReplyDelete
  24. re: "Is that an opinion on an out of context quote? Or of your own knowledge on Hazlitt's criticism?"

    It's a reaction to everything you've been saying, Mattheus.

    Current captured this whole discussion well with one mistake when he wrote: "
    Your view is that we have a complicated situation where there are many different options of differing liquidity and interest payment. I agree with you and so does Mattheus. But, you are projecting this idea into the text that Keynes wrote, not reading from the text."


    His one mistake was in say that I am projecting ideas onto Keynes.

    This is not the case. You two and Hazlitt are. And Hazlitt ADMITS HE IS. Hazlitt says he is treating "liquidity preference" as if it were "cash preference". He says that explicitly. If you all agree on liquidity preference, that's great - but I have no idea why you're sounding like you want to agree but are then refusing to acknowledge that this is what was in the General Theory all along.

    If we all agree, that's great. But don't act like you're criticizing liquidity preference when what you're actually doing is criticizing some dumbed down cash-hoarding model.

    If you're with Bob Murphy, Keynes, and me that's fantastic.

    ReplyDelete
  25. I earn a salary as a reward for parting with hours of my time. The fact that I earn a salary does not imply that I have no non-work time.

    That's not what Keynes is saying.

    To make the analogy proper, it would be that you can't earn a salary AND have non-work time AT THE SAME TIME. Nobody said you can't hold liquidity if you're earning interest in general. Keynes says that you can't earn interest and hold liquid assets IN THE SAME OBJECT.

    Which is again why I ask - have you and Hazlitt never heard of the marginalist revolution???

    Ha ha. Gee, funny. When you're done patronizing me, try to understand my position. Keynes certainly didn't make the argument that if you earn interest, you can't hold liquidity AT ALL - and I'm not trying to pin him on that absurd claim. All I'm saying (and Hazlitt as well) is that if interest is a price paid for the relinquishing of a MARGINAL AMOUNT of liquidity (in a savings account), that SAME MARGINAL AMOUNT cannot confer the benefits of liquidity precisely because it's earning interest! Of course you can hold liquidity in other areas; nobody denies that. But Hazlitt was making the point that certain interest-bearing instruments actually DID grant liquidity! It's like if I found a job that gives a salary at the same time as it gives me non-work time. It's a refutation that salary is a "reward for parting with non-work time" because I actually achieved both with the same unit.

    I am simply saying that if you want to criticize a cash-based theory, don't pretend you're criticizing a liquidity preference theory.

    I'm not criticizing a cash-based theory. I definitely understand that one person can hold more or less liquid assets, and if my word on the matter means anything, I guarantee Hazlitt knows this as well. That "cash preference" comment was a comment towards a previous point Keynes was making. It didn't have much to do with the reason I quoted him.

    When Hazlitt moves from talking about liquidity to talking about cash he makes it sound like Keynes is saying that you either have interest and no cash or no interest and cash. Either/or.

    ... Based on the two paragraphs I quoted? Really, Dan?

    Hazlitt devotes 2 chapters to this problem.

    Hazlitt basically throws that out the window and decides he doesn't want to have to deal with that by talking about cash-preference rather than liquidity preference.

    This is simply not true. Hazlitt's admission of the use of cash preference is an unfortunate use of phraseology. Hazlitt is specifically using cash preference to refer to certain comments Keynes makes prior. He is NOT turning liquidity preference into a CASH PREFERENCE theory in toto, but only to make a comment.

    It's a reaction to everything you've been saying, Mattheus.

    And what have I been saying? That Keynes was fixated on a cash fetish? That liquidity plays absolutely no role in what you and I talk about as "bank fees?" What is my point, Daniel?

    ReplyDelete
  26. Hazlitt says he is treating "liquidity preference" as if it were "cash preference". He says that explicitly.

    You're just building a strawman. Daniel, I have the book in front of me. He does no such thing. I've read these two chapters multiple times. Cash preference is a PART of liquidity preference, but Hazlitt isn't making Keynes out to be a cash fetishist. He writes further in the same paragraph:

    "If Keynes had confined his 'liquidity-preference' theory to a pure cash-preference theory, he would have had to confine his theory to pocketbook cash and under-the-mattress cash, plus the cash reserves of banks. For these are the only unused "hoards" in the system. And the great bulk even of these would have to be set down, even by Keynes, as cash kept for the 'transaction motive'"[italics his].

    If you all agree on liquidity preference, that's great - but I have no idea why you're sounding like you want to agree but are then refusing to acknowledge that this is what was in the General Theory all along.

    But we don't all agree on liquidity preference. That's the point. And I'm trying to prove to you that our disagreement is based on solid reasons, NOT that we're confusing it with a "dumbed-down cash hoarding model."

    Hazlitt writes a whole chapter on positive interest rate theory - comparing and analyzing the productivity theory (more or less, Knightian/Fisher neoclassical school), the time preference theory (Austrian school), combinations thereof, and finally he gets to Keynes, and deduces that liquidity-preference cannot be a suitable basis for the determination of the interest rate because parting with liquidity has nothing to do with time structure. Maybe you can explain how it DOES have something to do with it since "time is central in Keynes."

    ReplyDelete
  27. Clearly I'm missing something in your argument then.

    Your "have your cake and eat it too" that you referred to earlier just sounds to me like "interest bearing accounts still provide some degree of liquidity". To which my response is "Duh - so? Was this ever in question? By whom?".

    If you don't like my wage example, let's take something closer to securities - the spectrum of claims to assets.

    You get compensated for giving up claims to assets, right? But no one would balk at the fact that shareholders STILL hold residual claims to assets during a bankruptcy, right? You haven't presented a contradiction by showing that someone (1.) still has some legal claim, and (2.) they get compensated for giving up a claim.

    What is different here?

    Why are you investing so much in this fact that you can earn interest and still have liquidity? Why are you acting like this is so consequential?

    If I'm mistunderstanding an argument here, please enlighten me. But you used this word "contradictory" earlier, and I'm not seeing what contradictory.

    ReplyDelete
  28. To which my response is "Duh - so? Was this ever in question? By whom?".

    By Keynes, it seems. He writes that: "Thus the rate of interest at any time, being the reward for parting with liquidity, is a measure of the unwillingness of those who possess money to part with their liquid control over it."

    It seems like Keynes is arguing that the rate of interest is the price paid for giving up your possession of cake. You definitely can't eat it too!

    But no one would balk at the fact that shareholders STILL hold residual claims to assets during a bankruptcy, right?

    Eh, this has to do more with bankruptcy laws and not strictly economic science anymore. I understand what you're saying, and it must be my own vernacular deficiencies that prohibit clear expression of my ideas.

    Why are you acting like this is so consequential?

    Well, it's really not so consequential for me. Liquidity is a tertiary or quaternary consideration for the determination of "the interest rate." The most important element being originary interest (the preference for now vs. later), then entrepreneurial risk, then price premium, then maybe liquidity considerations in the broad sense. So this whole brouhaha really isn't important to me. To the extent it is important, as you rightly acknowledged the interest return on CDs and savings, it is such because of the specific banking policies enacted.

    It's just a refutation of Keynes' "purely" liquidity-preference theory of interest.

    But you used this word "contradictory" earlier, and I'm not seeing what contradictory.

    That was Hazlitt's phrase (again, the idea of cash preference was never central to my discussion - it was a tangent). He thinks liquidity preference is contradictory because Keynes implies that one cannot have his cake and eat it too (reward for parting with liquidity) and yet there exist interest bearing liquid assets.

    ReplyDelete
  29. I think I'm beginning to grasp the problem here....

    I think we all agree that a range of liquidity & interest options are available.

    The problem here is that Keynes at least appears to be saying that the interest is a payment for parting with liquidity. I'll quote again the section I quoted above: "...the mere definition of the rate of interest tells us in so many words that the rate of interest is the reward for parting with liquidity for a specified period"

    The problem Mattheus and I are seeing with this I mentioned at the beginning of this thread. A very liquid asset may pay interest. I once had a UK current account with a debit card that paid 4% interest per year. A current account with a debit card is the most liquid it gets in Britain, even cash is less liquid for some purposes. So, I had the most liquid asset that could be obtained in that economy and I was paid interest for it. This shows that all of the rate-of-interest can't be accounted for by parting with liquidity, some part of it must be accounted for by looking further afield.

    I think the argument between Mattheus and Daniel is confused about the subject. Daniel thinks that Hazlitt is proposing something much simpler than Keynes where a first order break is made between cash and everything else. In his view Hazlitt is thinking about cash as the most liquid asset and everything else as less liquid. Daniel is criticising this claiming that within "liquidity" Keynes meant to embrace many degrees of liquidity. Daniels' point is a reasonable reading of the excerpt from Hazlitt.

    Mattheus on the other hand thinks the discussion is about the point I made above. In his view Hazlitt considers some asset to be of greater liquidity than cash.

    This is what we really should say is... "a person may obtain a *greater* interest rate by parting with liquidity for a period of time". Because you can obtain an interest rate without parting with liquidity at all.

    ReplyDelete
  30. The phenomena of interest, and interest payments, exists in barter societies as the discount of present vs future goods. In its simplest manifestation then, interest is determined by time preference. Some economists contend (Mises, Rothbard) that in an ERE this will also be the case. That this is true is obvious. Consumer loans in a barter society between friends are made on the basis of pure time preference. There is a promise (taken to be absolute) of repayment at a certain later time, without threat of default or inflation. $100 dollars at 5% interest implies the borrower values $100 now more than he does $105 a year in the future.

    Then we enter into a money economy. Interest still exists as a time phenomenon, but the rate at which people will save and borrow differs because the value of money is a consideration (after all, money is half of all transactions). This introduces a price premium on the interest rate, as well as it introduces the aspect of entrepreneurial risk. the emergence of money gives birth to lengthier production processes and a common medium of exchange by which economic calculation can be made. These two forces act to push the interest rate higher than it would in equilibrium or in a barter society.

    The existence of fractional reserve banking influences the rate of interest insofar as it creates conditions where the liquidity of the saver is relevant to banking operations. CDs and demand deposits will frequently earn interest payments - not because relinquishing liquid assets is in any necessarily way tied to the phenomena of interest - but because banks are lending out the majority of demand deposits in the form of outstanding loans, and earn interest on them. Payment of interest on demand deposits is a manner of inducing savers to relinquish their capital, which most often happens to be expressed in liquidity - i.e., money. It is my contention that a monetary system without fractional reserve banking would eliminate the influence that liquidity plays in the determination of the market rate of interest. At any rate, it is no use in denying that "liquidity-preference," in our economy, has some force acting upon market rates of interest.

    Maybe by making headway on the above reading list I can refine my position.

    This is what we really should say is... "a person may obtain a *greater* interest rate by parting with liquidity for a period of time". Because you can obtain an interest rate without parting with liquidity at all.

    This is true, but I argue in the beginning this is only the case due to the prominence of fractional reserve banking where one can earn interest on demand deposits.

    ReplyDelete
  31. "This is true, but I argue in the beginning this is only the case due to the prominence of fractional reserve banking where one can earn interest on demand deposits."

    Not necessarily. Consider a hypothetical economy where the currency is land rather than gold. There are land certificates, and land bank accounts for an amount of land weighted by agricultural yield. There are banks that administrate these certificates and employ farmers to farm the land. But, these banks are not fractionally-reserved, all land is owned by one certificate holder. In this could be a yield to currency because the land has a yield.

    What causes your observation is that gold yields no (conventional) income while being kept as money. Once the money asset does yield a conventional income (through fractional reserves or something else) then the sentence I mentioned at the end becomes true.

    ReplyDelete
  32. re: "It seems like Keynes is arguing that the rate of interest is the price paid for giving up your possession of cake. You definitely can't eat it too!"

    OK, but I've responded to this quote several times now. If that's all you're coming back to, nevermind. I strongly disagree with the way you've chosen to read it.

    And yes, I think Current describes our different positions accurately - I tried to express that earlier, but apparently not successfully. It's not just the Hazlitt/cash point I was pressing back on, though. All considerations of his cash-prefrence dumbing down (I do think this was what he was doing) aside, I simply think you're misrepresenting liquidity preference as it's always been understood.

    ReplyDelete
  33. @ Daniel,

    "I'm curious why you date this back to 2006-2007"

    This was an completely erroneous thought... Clear case of writing before thinking. Sorry.

    @ Mattheus

    "I know, but I want all of these as physical books. I'm weird like that."

    Me too, but for CDs and Terry Pratchett. In economics I prefer to use my money on books I can't get for free.

    ReplyDelete
  34. Once the money asset does yield a conventional income (through fractional reserves or something else) then the sentence I mentioned at the end becomes true.

    In the first place, "land" isn't any more productive than money is. Land is only productive when you employ labor and capital to it. You get returns from cultivating land, but you also get returns from saving money. The long-run tendency of both are to equalize according to the uniformity of profit principle - where the rent on a marginal piece of land is equal to the interest earned on a marginal unit of money.

    In the second place, land would never be used as a currency. Land is quite possible the most illiquid asset ever - and certainly not the most marketable. Money develops in a barter society when goods become sought for indirect exchange, and they become more marketable as they universalize among traders. Land does not satisfy that criterion - for the simple reasons that not all land units are equally serviceable and hence there is no "good" called land that enables widespread trading; and because the supply of land is open to fluctuation that doesn't exist with the more historically-chosen mediums of gold and silver.

    This is empirically so unlikely it's barely worth arguing over. No medium of exchange earns income "on its own."

    I strongly disagree with the way you've chosen to read it.

    Then enlighten me, Daniel. Where am I misunderstanding Keynes?

    I simply think you're misrepresenting liquidity preference as it's always been understood.

    I'm clearly not the Keynesian scholar in the room, that's for sure. If I'm misrepresenting something, please educate me.

    ReplyDelete
  35. Mattheus,

    I think you misunderstand my comments. I'm not suggesting that land should be used in practice as money (though it has been in the past). My point is to break the close association between fully-reserved money and zero-interest payment.

    I agree that land is only productive when capital and labour are applied to it. But, the owner of the land still earns a rent, as you yourself point out.

    In my hypothetical example the bank would get tenant farmers to farm the land and charge them a rent. You point out that there are returns from saving money. In a 100% reserve gold system the only return if money itself is saved is the "Yield from Money Held" as Hutt put it. Not so in the "land money" system I'm describing here.

    I agree this is a point of abstract theory, not great empirical relevance.

    ReplyDelete
  36. The way I see it, liquidity-preference becomes irrelevant to interest rate considerations when there is a clear distinction between time deposits and demand deposits. And there is only a clear distinction between these two different catallactic phenomena in a 100% reserve banking environment - because then, demand deposits cannot earn interest as they are required to sit idle.

    ReplyDelete
  37. I "part with liquidity" when I buy consumer goods, why don't I earn money interest then?

    Under conditions of rapid inflation, people start to have very low liquidity preferences, and yet interest rates rise to very high levels. Similarly, when inflation is more stable, liquidity preference is higher, and yet interest rates are lower. This is directly contradictory to the liquidity preference doctrine.

    Liquidity preference simply isn't an explanation for interest rates. It's time preference as manifested by the investment / consumption ratio.

    ReplyDelete

All anonymous comments will be deleted. Consistent pseudonyms are fine.