Thursday, August 8, 2013

On Austrians and the natural rate of interest

I don't often write about Austrians. As I noted before the reason is that, as a school of thought, Austrians are kind of irrelevant. They are part of the marginalist mainstream, but are often confused as heterodox (sometimes even Austrians don't know that they are neoclassical). In fact, Hayek was for the most part forgotten after Sraffa and others showed the inconsistencies of his theories in the 1930s, and if Austrians understood the consequences of the capital debates, their come back in the 1970s would seem even less reasonable.

Throughout their underground period, from the 1940s to the 70s, they were part of 'secret' societies in which only the initiated (complete adherence to the ideology) could participate, like the Mont Pèlerin Society, and creating think tanks, like the conservative Institute for Economic Affairs (IEA), to promote the laissez faire ideology (note this had no basis in theory, since they cannot prove that markets produce efficient allocation of resources with a uniform rate of profit, but I'll get back to that below).

It was the rise of the conservative movement, a sort of Polanyian reaction to the Welfare State, that brought back all sorts of laissez faire cranks, and brought in the coattails Hayek and his disciples. In contrast to Milton Friedman, that used a fairly regular ISLM cum Phillips curve model, with the added natural rate, Hayek produced no relevant innovation, besides some poetry about the complexity of markets and uncertainty (which is why some confuse him with an heterodox author; blame Shackle for this).

Sissela Bok, the daughter of Gunnar Myrdal,* co-winner of the Sveriges Riksbank Prize with Hayek in 1974, recounts in her biography of her mother Alva [Alva Myrdal, Gunnar's wife received a real Nobel, the peace one in 1982] that the prize was given to Hayek by the Swedish economics establishment as a way to demean the prize. And if this is not enough, the guy that was supposedly for freedom, and for economic freedom because that one is central for political freedom, defended Pinochet. So really there is no economic or moral reason to take Austrians too seriously.

In sum, Austrians are really the most ideological wing of the neoclassical school, with all the other theoretical problems that the mainstream has. There is not much relevant to discuss there. So you might ask what is the post doing here. The reason is that there has a been a debate between Lord Keynes (nope not that one, the author of the very good blog Social Democracy for the 21st Century) and a Spanish Austrian author, and I was asked about my opinion. So here it is.

Some Austrians seem to think that their theory does not require a natural rate of interest. This might be the result of an incomplete understanding of Sraffa's 1932 critique of Hayek, in which he showed that there were as many own rates of interest (Sraffa's term) as commodities. At any rate, in the this recent debate the Austrian author says that in order to have a cycle Austrian don't need a natural rate and that:
"it suffices with showing that there is a mismatch between the term and risk structure that the marginal lenders (savers) are willing to fund and the term and risk structure associated with investment taking place in the economy." Or in Spanish in the original post: "le basta con mostrar que existe una descoordinación entre el plazo y el riesgo de las inversiones que están dispuestos a financiar los ahorradores marginales y el plazo y el riesgo asociados a las inversiones que se están efectuando en la economía."
So basically you need a mismacth between savings and investment. And dude, yes at the actual intersection of these two curves (often well behaved with savings being upward-sloping and investment downward-sloping) is an equilibrium interest rate, that would eliminate the mismatch. That's your natural rate. So, yes Austrians do have a natural rate**, even if they don't know it. Note that the capital debates show exactly that the idea of natural rate of interest inversely related with capital abundance (supply and demand) is not tenable. The poetry on market efficiency depends on being able to prove that. That's why the neoclassical project, and with it Austrians, has been derailed. It is really zombie economics.

* Myrdal coined the term monetary equilibrium to refer to the Wicksellian notion of an equilibrium between the natural and monetary or bank rates of interest. He also was a proto-Keynesian, and the key economist in the initial social democratic governments of the 1930s.

** According to Garegnani, in fact, even the inter-temporal Arrow-Debreu models, which supposedly do not have a uniform rate of profit, require a natural rate of interest to bring about the equilibrium of investment with full employment savings.


  1. Who cares about capital controversies?

  2. Again Irineu, anybody that is interested in how real economies work. Read the good paper by Franklin Fisher and Jesus Felipe on why should care about the capital debates and aggregate production functions. You might learn something for a change.

  3. 'And dude, yes at the actual intersection of these two curves (often well behaved with savings being upward-sloping and investment downward-sloping) is an equilibrium interest rate, that would eliminate the mismatch. That's your natural rate"

    Surely you're describing the market rate here not the natural rate?

    1. Hi Rob:
      Nope, the equality between savings and investment is the very definition of the natural rate of interest, at which capital is being fully utilized. Note that to derive the investment schedule you need full employment in the labor market (the reason why at lower rates of interest they substitute labor for capital, which is now cheaper, is that labor is fully utilized; otherwise the price of labor would fall too and there would be no reason for substitution). Hence, when S=I you have full employment and no inflationary pressures (so it is the rate compatible with stable prices). The monetary rate, or banking, is some deviation from the natural one. See my post on Wicksell. This (Loanable Funds Theory) is the basis of neoclassical theory of interest and is what Hayek defended in the 1930s.

    2. Thanks for the clarification.

      In your footnote you say "Myrdal coined the term monetary equilibrium to refer to the Wicksellian notion of an equilibrium between the natural and monetary or bank rates of interest".

      I guess in the Wicksellian model when these rates differ there will actually be a discrepancy between I and S and the money supply (and prices) will adjust as a result.

      However I am not sure this is the case with traditional ABCT. An increase in the money supply normally starts the cycle and means that the market rate has to fall to clear the loans market. This leaves it below the natural rate (which is the rate reflected in relative prices in the real economy, or the rate that would exists under barter as it is sometimes described).

      However at this disequilibrium market rate I and S are still in fact equal just not at a sustainable level (part of the savings are "forced" savings).

    3. Hi Rob:
      Yes, you can have a monetary shock (as Hayek and most Austrians did) or a real shock (as Schumpeter did). In both cases that generates a disequilibrium between the bank rate (LM) and the natural rate (IS) (see the post on Wicksell here Forced savings, caused by inflation which reduces consumption while I>S and the bank rate is lower than the natural rate, runs its course unless you are in a pure credit economy, and then the bank rate goes up (as bank reserves dry out) and and equilibrates with the bank rate.

      Hayek says so here in Prices and Production (p. 23) (, explaining Wicksell:
      "If it were not for monetary disturbances, the rate of inter- est would be determined so as to equalise 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."

      Note that he suggests that Mises, and him build, on Wicksell, but the former's contribution had (p. 25) "improved the Wicksellian theory by an analysis of the different influences which a money rate of interest different from the equilibrium rate exercises on the prices of consumers' goods on the one hand, and the prices of producers' goods on the other."

      So again. Yes there is a natural rate, and in all fairness Wicksell said it all before.

    4. I would recommend the reading of the good entry by Gonçalo Fonseca at the New School History of Thought website here


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