"For what it's worth, I think Hayek has a more useful set of ideas on the business cycle than Mises anyway. Keynes even made basically the point in Ch. 16 of the GT that Hayek does in Prices and Production - that a lower interest rate will make production processes longer (and also more capital intensive - but the elongation is the main point). Hayek's business cycle theory hinges on the fixed [and specific] nature of those investments in longer production processes. That guarantees that adjustment is not costless. I'm not that familiar with Mises, but I don't think he has that mechanism that Hayek does.
My concern with all the Austrian work is that while it may be a very interesting description of what happens to what they call the "time structure of production" in response to the interest rate, there's no obvious reason to tie that to the business cycle. Their story is "during the boom interest rates are artificially low, and during the bust they go back to their natural rate". In a loanable funds world, that makes sense. But in a liquidity preference world, the story is "interest rates are too high for full employment". In a liquidity preference world where those interest rates are kept too high by a zero lower bound, you of course have even more trouble.
So the whole Hayekian story is predicated on the assumption that we move below Wicksell's natural rate during the boom, and return to it in the bust. Our best understanding of macroeconomics (from Hicks et al.) says that we're at Wicksell's natural rate during periods of full employment, and are above it during the bust.
In other words, the Hayekian mechanism should produce a capital structure that is just right during the boom and too short during the bust - exactly the opposite of their normal story.
So while all the fluctuations of the "temporal structure of capital" are quite interesting to me, I don't think they offer much in the way of a business cycle theory."
Wednesday, November 16, 2011
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> I'm not that familiar with Mises, but I don't think he has that mechanism that Hayek does
ReplyDeleteThat's an interesting point I'm not sure either. I think Bohm-Bawerk has that point and Mises leans on Bohm-Bawerk by referring to his aggregate capital concepts (Subsistence fund & average period of production).
Neither Hayek nor Mises assume that the rate of interest returns to the natural rate. Mises specifically mentions it rising above the natural rate in a recession, and I think Hayek does too but I'm not sure.
You're quite right that your interest rate theory is different from Austrian theory. I plan to write a paper about that some day.
The Austrian Business Cycle Theory is incorrect. Hayek is illogical in his exposition of the supposed relationships between interest rates and the (temporal) capital structure of the economy. Those who have studied the "fixed [and specific] nature of ... investments" know that it is not necessarily true that "lower interest rate will make production processes longer."
ReplyDeleteI agree analytically with the existence of reswitching and capital reversing. But, I don't think they are likely issues in practice.
ReplyDeleteThe interesting thing about theories of interest is nailing down exactly what people mean and what time period they're thinking of.
ReplyDeleteI think Daniel said a while ago that he thinks lots of things affect the rate of interest. I agree with that.
What I've found by reading about it is that the difference between "broad" and "narrow" concepts of interest is very important. When some people speak of interest they're only talking about the rates available on short-term accounts, and those charged on short-term loans. In other formulations there are businesses with rates of profit that comprise risk premium and interest, and landlords rent is related to interest. That's a much broader, and longer-term idea.
Everyone talks about how lending affects equity markets and rent, but there isn't much consistency about whether that's described in terms of the interest rate.
Part of the problem too is the different meanings of "flow". In income accounting flow doesn't mean the same thing it means in supply-and-demand models. Lots of confusion can be produced by assuming that it does.
Out of curiosity, Daniel Kuehn, what editions of Ludwig von Mises's books do you own? What editions of F.A. Hayek's books do you own?
ReplyDeleteI own a 50th anniversary edition of F.A. Hayek's "The Road to Serfdom", published by the University of Chicago Press, but I do not own anything by Ludwig von Mises.
Hayek's business cycle theory hinges on the fixed [and specific] nature of those investments in longer production processes. That guarantees that adjustment is not costless. I'm not that familiar with Mises, but I don't think he has that mechanism that Hayek does.
ReplyDeleteHe does. Not in the early pre-Hayek years, but by Human Action this concept is definitely expressed. Maybe you should read his work on business cycles? You always mention how little you know about Mises.. this might give you a little more insight on ABCT (since you express an interest in it).
But in a liquidity preference world, the story is "interest rates are too high for full employment". In a liquidity preference world where those interest rates are kept too high by a zero lower bound, you of course have even more trouble.
Well, right. And this is why we constantly have fights on interest rate theory. Which goes back to demand for money theory and other such principles. Liquidity preference is the biggest disagreement. If you held a time preference theory of IR, we'd be brothers in all but ethics.
"Our best understanding of macroeconomics (from Hicks et al.) says that we're at Wicksell's natural rate during periods of full employment..."
We all agree with this. Wicksell's natural rate is an equilibrium rate. Certain conditions hold in general equilibrium, these two are some of them.
But I think you're misunderstanding Wicksell. The natural rate is a rate that equalizes time preferences; the ratio of consumption and investment. Wicksell is working within a loanable funds model - because capital and time preferences are inseparable - so I don't see how you can use Wicksell with a liquidity preference model.
In other words, the Hayekian mechanism should produce a capital structure that is just right during the boom and too short during the bust - exactly the opposite of their normal story.
You can't pick and choose which part of Hayek and Wicksell to use. Either you agree that Wicksell's natural rate equalizes time preferences - and that the interest rate is an expression of time preference - or you do not. There's no sense in taking half of Wicksell and half of Keynes and using it to debunk Hayek.
Mattheus -
ReplyDeleteTo say that there is an interest rate which equalizes time preferences and to say that the equalization of time preferences determines the interest rate are two quite different things.
Daniel,
ReplyDeleteWhat is "an interest rate?" I'm only familiar with "the" interest rate.
"To say that there is an interest rate which equalizes time preferences and to say that the equalization of time preferences determines the interest rate are two quite different things."
ReplyDeleteIt is. But this makes your view that during a boom we are at *Wicksells* natural rate all the more puzzling.
There's a problem here I've often discussed before... Wicksell defines the natural or neutral rate in several ways....
* As the Interest rate that keeps prices grow at the trend rate (0% or lower in Wicksell's time).
* As what the equilibrium interest rate would occur if there were no intermediation by money in the economy.
* As the long-term sustainable rate in terms of intertemporal preferences. ("Equalizes time-preferences" in Mattheus' terms).
Do you think one or more of these criteria can be met even if the liquidity-preference theory is correct? Do you have a model for this?
> What is "an interest rate?" I'm only familiar with "the" interest rate.
ReplyDeleteDaniel is saying that there is an interest rate that equalizes time-preference, but that's not the interest rate markets in debt and money would produce in all cases.
I agree with him there, indeed even Mises does. But I don't agree with all of the rest.
but that's not the interest rate markets in debt and money would produce in all cases.
ReplyDeleteI have to ask.. So? If we're talking about business cycle theory, we're talking about theories on output, capital, and price fluctuations.
We should really only be interested - as far as business cycle theory goes - in discussing the Wicksellian interest rate because this is what combines the activities of savers and borrowers. This is crucial to explain output variations and investment patterns.
I have reposted this absolutely excellent comment on my blog with a link to you. Is this OK with you?
ReplyDeleteSure.
ReplyDeleteNo need to ask in the future. I put it out there for all to see, after all.
Mattheus,
ReplyDelete"We should really only be interested - as far as business cycle theory goes - in discussing the Wicksellian interest rate because this is what combines the activities of savers and borrowers."
I'm surprised you're not getting this :)
Daniel is agreeing with the idea that there is a socially optimal interest rate, a "natural" rate. But then we have to consider what interest rate we will actually get, what interest rate our markets and institutions will produce in any given circumstance. Daniel's view is that this isn't always the socially optimal rate.
As I understand it what he's saying in this post is that the boom represented a *sustainable* situation which could have continued had it not being for human irrationality. In his view our current situation is one of true underproduction where the amount of real output is far below what it could be (and it could have followed the same trend as the boom).
I don't agree. But, I agree that Daniel is quite right to discuss deviations between the actual interest rate and the neutral/natural interest rate.
It’s always nice to see a “critique” of Austrian theory which leaves out its basic concepts. People act and have limited knowledge. The primary source of economic knowledge and information are the prices paid for goods and services. Economic calculation by individuals each with a unique and subjective value system guided by prices is the essence of the Austrian theory. This analysis applies to both the “socialist calculation” situation where prices do not exist or to prices distorted by Keynesian fiat money and spending schemes. “Lord Keynes” makes his living denying the latter application without proof or analysis as a matter of course.
ReplyDeleteI hope that there is no debate that Keynesian policy lowers interest rates and injects fiat money into the economy which allows prices to be bid up higher than otherwise. That’s the point of Keynesian policy, right? The first problem with Keynesian stimulus is that it intends to solve a problem that does not exist. The free market does not and will not tend to systemic unemployment. The primary effect of Keynesian policy, especially monetary policy, is to seduce citizens into thinking that they and the rest of society are wealthier than they actually are due to the rising prices and availability of new money. This process will tend to make long term and more complicated investment seem more profitable than it really is. However, because people are not only poorer than they think they are, they will be poorer still due to the misdirection of the labor and capital into lines of production which seem profitable only due to low interest rates, plentiful funny money loans and rising prices. Fiat money short circuits the price-information system. The bust will invariably arrive when it becomes obvious there isn’t a bunch of new wealth to satisfy the new artificial price and debt structure.
This is exactly what happened with the housing bubble. People were induced to invest in housing because it appeared profitable only because of the presence of fiat money loans. But people didn’t actually have $800,000 worth of stuff with to trade in the long run for a $150,000 house. Without the fiat money system, even “Lord Keynes” concedes that there would be nothing but a long perpetual period of “deflation”, slowly falling prices for everything (which I think is great and he thinks is a tragedy). Can we all agree that no one would ever need to purchase real estate as an inflation hedge in such a society? And that the only long-term investment that would take place would require actual real savings (the foregoing of consumption) by real people at interest rates such lenders demanded and borrowers agreed to pay? And that such interest rates would probably be higher than fiat money interest rates?
The only flaw in Hayek’s model is that he lived before the advent of fiat money consumer credit for the masses. Such consumer credit allows a long term capital goods (and durable consumer goods) bubble to coincide with a consumer credit bubble.
These critiques simply refuse to understand basic Austrian concepts so that the critics might force the general Hayekian system into a straight-jacket
Are you arguing here that as we have full employment during the boom and unemployment during the bust that from a Wicksellian perspective interest rates must have been right during the boom and too high during the bust?
ReplyDeleteIf so then I don't think this is the right way to view it. Both in equilibrium and in an artificial boom there will be full employment. The difference is rather than in the later case (during a period when IRs are too low)there is a over-investments in capital goods, which will prove unsustainable and lead to the bust.
During the bust there is unemployment not because the IR is now too high but because the structure of production is broken and it takes time to rebuild it to reflect the natural rate of interest (plus of course due to the likely AD effects of the Hayekian "secondary deflation")
So unlike the Keynesian model where there is a direct path from lower interest rates -> higher employment the Austrian model would see the path being via the effect that IRs have on the structure of production.