There is something wrong with anti-austrians’ view on the multiple interest rates. I want to clarify this point.
Dr. Hayek on Money and Capital – by Sraffa
If money did not exist, and loans were made in terms of all sorts of commodities, there would be a single rate which satisfies the conditions of equilibrium, but there might be at any one moment as many “natural” rates of interest as there are commodities, though they would not be “equilibrium” rates. The “arbitrary” action of the banks is by no means a necessary condition for the divergence; if loans were made in wheat and farmers (or for that matter the weather) “arbitrarily changed” the quantity of wheat produced, the actual rate of interest on loans in terms of wheat would diverge from the rate on other commodities and there would be no single equilibrium rate.
Money and Capital: A Reply – by Hayek
I think it would be truer to say that, in this situation, there would be no single rate which, applied to all commodities, would satisfy the conditions of equilibrium rates, but there might, at any moment, be as many “natural” rates of interest as there are commodities, all of which would be equilibrium rates; and which would all be the combined result of the factors affecting the present and future supply of the individual commodities, and of the factors usually regarded as determining the rate of interest. There can, for example, be very little doubt that the “natural” rate of interest on a loan of strawberries from July to January will even be negative, while for loans of most other commodities over the same period it will be positive.
Let us take Mr. Sraffa’s case in which the farmers “arbitrarily changed” the quantity of wheat produced – which I understand, from what follows, to mean that they, for example, so increased the supply of wheat that its price fell below its cost of production and, as a consequence of its temporary abundance, loans of wheat were made at a much lower rate of interest than loans of other commodities. But would that fall in the rate of interest on wheat-loans cause anyone to start roundabout processes of production for which the available subsistence fund is not sufficient ? There is no reason whatever to assume this. In so far as people live on wheat, they will actually be provided with food for a longer period; and in so far as the lower price of wheat will induce people to eat more of it – instead of something else – these other goods will also be available for a longer period of time, and interest in terms of these goods will also fall. The effects will be just the same as if a corresponding amount of wheat had been saved, and when, as a consequence of the fall in the price of wheat, its output falls again, the accumulation of capital made possible by the surplus of wheat will supply cease.
The result would be different only on condition that investors are caught in the illusion that there are more wheat than actually available. In a regulated monetary economy, where a central bank arbitrarily manipulates the supply of money, this can occur at any time. But it is unclear how, in a barter economy, such a distortion of the temporal horizon, and thus the structure of production, could occur.
The case would, however, be different if the actual supply of wheat were not changed, but if, under the mistaken impression that the supply of wheat would greatly increase, wheat dealers sold short greater quantities of future wheat than they will actually be able to supply. This is the only case I can think of where, in a barter economy, anything corresponding to the deviation of the money rate from the equilibrium rate could possibly occur.
Even if there are multiple natural rates of interest, I think all natural rates have a tendency to converge. That there are one or more natural rate does not change anything to the premise. In a barter economy, economic agents do not invest more than the amount of their economies, which are not disproportionately misallocated to the higher stages of production. And this because all commodities are real economies, real subsistence fund. Sraffa completely missed that point.
A Rejoinder – by Sraffa
Once more Dr. Hayek himself provides me with the argument against his theory, by appending here this footnote: “Except for such amounts as may be absorbed in cash holdings in any additional stages of production”. Exactly; and if Dr. Hayek had taken as much pains in writing his book as his reviewer has taken in reading it he would remember that under his assumptions such cash holdings will absorb not merely certain exceptional amounts, but the whole of the additional money issued during the inflation; that consequently incomes cannot rise at all, and there will be no occasion for any dissipation of capital.
Manipulating interest rates leads to a distorted time preference. And natural rate (or rates) is time preference or price(s) for present goods, i.e., savings. Since the market rate is below the natural rate, cash holdings cannot absorb any additional money. Overexpansion only leads to capital consumption. In fact, to prevent the malinvestment process, it would be necessary for economic agents to save all of the new money created by the banking system, which is practically impossible.
Dr. Hayek now acknowledges the multiplicity of the “natural” rates, but he has nothing more to say on this specific point than they “all would be equilibrium rates”. The only meaning (if it be a meaning) I can attach to this is that his maxim of policy now requires that the money rate should be equal to all these divergent natural rates.
Yes, “all would be equilibrium rates” because banks lend real savings to the extent there is no distortion in time preference. The interest rate is supposed to express the equilibrium between individuals’ voluntary savings and investments, and the divergence of the market rate from the natural rate is just another way to express the equation. Even if the concept of “the” natural rate is invalid, the ABCT as theory of disequilibrium remains intact. The rejection of “the natural rate” concept does not invalidate the idea of temporal discoordination between the investors (willing to save) and entrepreneurs (willing to borrow). Artificial money induces entrepreneurs to borrow more, but does not induce the investors (i.e., savers) to save more money because the surge in investment is not caused by any increase in willing to delay consumption, which would be reflected by increases savings (or “demand for money to hold”, see Selgin 1988). And this, especially if monetary (over)expansion is the key concept of the ABCT, not the interest rate per se.
It is worthwile to recall that the interest rate is “just” a price for present goods (savings). The prices for present goods tend to be homogeneous, thanks to competition. To focuse on the possibility of mutiple interest rates is somewhat irrelevant. If the different prices for present goods tend to fall, this is only due to a lower time preference.
Saying that the existence of multiplicity of interest rates disproves the ABCT is like saying that the amount of saving can’t determine the amount of money the bank could loan. In fact, the less people consume and the more people save, the more banks loan money, and the more the production structure lengthens. That’s the core of ABCT.
Further reading :