The Posts War: A Rejoinder Post to a Reply Post from a Post Keynesian

It looks like I have unleashed Armageddon as I thought. “Lord Keynes” (LK) has replied me here. So this post is to answer his accusations. Ok LK, let's dance. You will not break me ;)

But first three positive points from his reply:

1) He spent time in reading and writing about my post.

2) He did not insult me as much as I expected :D

3) I fully agree with him in this correction: quantitative = “quantity”. Sorry, my bad.

Now let’s answer some issues:

"If I am not mistaken, Guillermo Sanchez already acknowledges that Sraffa’s critique of Hayek on the non-existence of the Wicksellian natural rate of interest is sound."

Actually what I have said was that Mises’ theory of interest was different and (much!) better than Wicksell’s. Nobody can deny that monetary rate can be (temporarily and unsustainably) deviated from the rate that would have prevailed without the intervention of (banks creating) credit expansion necessary to cause that deviation. However that deviation has inevitably unintended consequences, and the market process that acts to return to a rate not manipulated and determined for the “real” economic situation of temporal valuations of individuals is precisely the cycle. Besides the post in which I criticised LK, had bibliography against Sraffa.
 
Let's go to a point by point response:

(1) He makes a totally false accusation. There is no “red herring”: Until this post, he did not mention the fact that Keynes was a Wicksellian when he criticized Hayek or ABCT. My point was to demonstrate that he, in his post criticizing ABCT because Hayek used natural rate, did not say anything about Keynes also using Wicksell’s natural rate; and LK did not do it (until now). That’s undeniable. Then he says that Keynes abandoned that idea, something I clearly also said in my post. Again: the point I made was that he did not mention Keynes’ “dirty” Wicksellian past; he was a natural rate theorist in exactly the same moment in which Sraffa was attacking Hayek for been a Wicksellian. So LK should have mentioned Keynes’ antecedents in at least one of his 20 blog posts (I don’t know the exact number) dedicated to criticizes another guy (Heyek) because he (along with Keynes) was using the Wicksellian concept. Did he mention that fact? No, and it is easy verifiable, just look at his posts criticizing natural rate and you will see that he did not mentioned that. So there is absolutely no red herring here.

(2) The only point to demonstrate was that LK attacked Hayek because he used Wicksell’s natural rate, but he did not attacked Keynes (until his post criticizing me) for using it in his analysis. My objective was to show his arbitrary criterion of choosing Hayek as his victim, but “forgetting” Keynes. My accusation of him using a “double standard” was based in the fact that: If you made a post attacking someone (Hayek) because he used Wicksell’s natural rate, and you do not attack other guy (Keynes) who also used it at the same time, you have been dishonest with your readers. My accusation of dishonesty from his part in those previous posts is still standing. However he confessed it in replying me.

(4) 

"The word “scarce” can have two meanings: (1) finite, and (2) insufficient quantities available in relation to demand. When I say that something is “relatively abundant,” I mean that it is available in a quantity that exceeds the demand for it."

LK did not, I repeat did not, use the words “relatively abundant”, you can look for it in the whole post and you will not find it. His actual words were: “Mises still fails to address the issue of what would happen had the factor inputs or consumer goods NOT been SCARCE.” If, in saying "not been scarce", LK is talking about factors been “available in a quantity that exceeds the demand for it” then he talks about a surplus of them, which is exactly what Mises was talking about! [“At times, even on the unhampered market, there are some unemployed workers, unsold consumers’ goods and quantities of unused factors of production, which would not exist under “static equilibrium.” (quoted and coloured by LK himself)] So that makes me wonder: What in the world was LK criticizing then? He attacked Mises for not “assuming” a surplus of factors of production when the austrian actually clearly and explicitly was doing that!

The phrase LK used (“not scarce”) can also have two meanings: (1) infinite, and (2) sufficient quantities available in relation to demand. The (2), and also (1), can actually be the definition of a free good!

"Free goods are things that exist in superfluity, that is, in quantities sufficient not only to gratify, but to satisfy all the wants that may depend on them.”[1]

This is more than a semantics problem. What is called a “free good” is actually the opposite of a scarce good i.e. an economic good (scarce in relation to its demand). When LK said “not scarce” the “not” word implies opposition, so I was perfectly right in talking about he assuming Garden of Eden. Another easily verifiable fact just looking at his post. There is no straw man here (and if you read my post you will see I "predicted" he will try to scape his own Land of Cockaigne assumption in this way), anyone can check the phrase “factor inputs or consumer goods not been scarce”. 

“But relative scarcity and relative abundance in these senses exist, and an economy can have a relative abundance of certain goods in any time outside a boom. [At times, even on the unhampered market, there are some unemployed workers, unsold consumers’ goods…]

Pay attention to what is in brackets, that is what Mises said in 1928. It is actually what LK is asserting! 

LK says: 

"Nor do I deny that as an economy expands and reaches a boom, inflationary pressures build up as resources become less available."

But he himself had said:

“All that Mises does is admit the fact that capitalist economies do have idle resources, but then says that his cycle effects require that this abundance declines and the relevant factor inputs become scarce.”

“If an economy with significant idle resources has investment via fractional reserve banking or central bank creation of excess reserves (without prior saving in loanable funds), how will these inflationary pressures happen if productive resources simply do not need to be freed in the stages close to consumption? Such factor inputs will be available or quickly made available through increasing capacity utilization in the relevant industries.”

“the charge against ABCT is that its cycle effects do not occur if the factor inputs and consumer goods required by expanded demand are not scarce.”

“Versions of ABCT dispensing with a Wicksellian natural rate of interest fail to explain why the cycle effects would happen if factor inputs were not scarce and available through international trade.”

Does everyone notice the contradiction here? He is criticizing misesian ABCT because “his cycle effects require that this abundance declines and the relevant factor inputs become scarce” and that “its cycle effects do not occur if the factor inputs and consumer goods required by expanded demand are not scarce” and also that “The objection that an economy where factor inputs are relatively abundant still poses a serious problem to the Austrian business cycle theory”. He even ask “how will these inflationary pressures happen if… factor inputs will be available or quickly made available through increasing capacity utilization in the relevant industries?"

However later on he acknowledges that “as an economy expands and reaches a boom, inflationary pressures build up as resources become less available”. In other words he says ABCT is false because it assumes factors becoming scarce in the boom, but he asserts that in the real world factors can be not scarce. However suddenly he says that he doesn’t deny that an economy that expands in a boom will face scarcity of factors.

If Mises’ “cycle effects require that this abundance declines and the relevant factor inputs become scarce” during the boom phase and LK has admited that “as an economy expands and reaches a boom, inflationary pressures build up as resources become less available”, then Mises theory is totally correct! I have to repeat this because it is an obvious “Lord Keynes Kontradiction”.

(3) Do you think I forgot point three? Of course not! I left it to the end because is amazing. LK makes an impressive statement:

“Interest is a monetary phenomenon, not explained by time preference.”

The absolutely refuted fallacy that interest is a monetary phenomenon must be in the Top Five of the Greatest Economics Myths of all times. One of the greatest achievements of economic science was the discovery that interest is not merely a monetary phenomenon. We know that since, at least, the days of Hume. The economists had completely destroyed that fallacious explanation from the prescientific days of economic science until Keynes revived it. But as it is completely impossible to revive a person from death, all you can do is to create a zombie, and that is what Keynes did in “reviving” that old fallacy.  

That "theory" has serious problems: 1) If interest is only monetary, then we can make interest disappear lastingly only by increasing money supply offered to loans. That's all! And finally we can achieve the paradise of “gratuitousness of credit”. The fact that theoretically and in practice that is not proved at all and has never happened, is enough proof to refute such machination. 2) In thinking this way he necessarily is implicitly denying interest! 3) Interest would prevail even in equilibrium, in contrast to money. Money (as we know it) disappears in equilibrium to transform itself into a numeraire, but interest prevails as a unique-uniform-equilibrium rate. And, as Sraffa acknowledges [“I pointed out that only under conditions of equilibrium would there be a single rate… 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...”], even in barter economy in equilibrium there will prevail a unique rate of interest (and outside equilibrium there would be "multiples", acordin to him of course). So even in a world of equilibrium there must be interest and has nothing to do with money (which does not exist as our "money") 4) Without interest there would not be maintenance or reinvestment of capital. With zero return, those things would be impossible. 5) The fact that interest is normally paid in money, is not evidence at all that it is a monetary phenomenon. Wages, profits and rent are also paid in money. As Hazlitt said: “Keynesians might go on to object that interest is paid not only in money but for money; that in this sense the phenomenon of interest is "purely monetary," and is merely to be explained in terms of the supply of, and demand for, loanable funds. This type of supply-and-demand theory, often met with in current economic textbooks, is not incorrect, but it is superficial and incomplete. When we go on to ask what in turn determines the supply of, and demand for, loanable funds, the explanation must be made largely in real terms. But Keynes explicitly denies the relevance of these real factors… It is true that interest is paid in money, and on a capital sum usually specified in money, and that therefore monetary factors have to be considered, especially when considering dynamic changes in the rate of interest. Keynes's fallacy consists in assuming that because monetary factors can be shown to affect the rate of interest, "real" factors can safely be ignored or even denied.” No respected and serious economist has ever dedicated more than a chapter or a subsection to this superficial myth.

Fisher in 1907 was certainly right in calling this a “Crude Theory” of interest. It is so superficial that can deceive man-on-the-street or a business-man, but should not deceive any respectable economist:

"A special version of the theory that interest depends on the "use of money" is found in the very persistent belief that the quantity of money in circulation governs the rate of interest, - that the rate is high when money is scarce, and low when money is plentiful. The shallowness of this theory has been exposed repeatedly by economists from the time of Hume to the present. It requires only a little reflection to see that, although an increase of the quantity of money in circulation will increase the supply of loans, it will also equally increase the demand. For instance, a piano dealer who borrows $10,000 in order that he may add to his stock in trade 50 pianos costing $200 a piece would, if the supply of money were doubled, require a loan of double the amount; for such an inflation of the currency would double the cost of his stock, and in order to obtain 50 pianos - costing now $400 apiece instead of $200 he would have to borrow $20,000 instead of $10,000. In spite of such reasoning, showing that an inflation of the currency must act on the demand for loans as surely as upon the supply, the theory that an abundance of money lowers the rate of interest is nevertheless widely accepted even among intelligent business men. Yet facts do not, any more than a priori reasoning, lend support to this belief. The probable reason for the persistence, among business men, of the opinion that an abundance of money reduces the rate of interest is the observed fact that the rate of interest is high when the reserves in banks are low, and vice versa, and that the rate in a loan center can be materially reduced by bringing to that center a supply of actual money to relieve the "stringency." This is true, and it is not denied that money plays a part in determining the rate of interest. But the part which it plays is chiefly as a puppet of other and mightier factors. The fundamental causes at work in a "money" market are not monetary at all, but economic. The economic causes operate through money and seldom show themselves save under a money disguise; but, generally speaking, money is only their instrument, not an independent factor. If money is plentiful for loan purposes, it is because its owners decide to apply it for these rather than for other purposes, and not because money in general is plentiful. The owners of money determine the purpose to which it shall be applied. To understand the real causes at work in the loan market, we must go back of the money itself and learn the reasons for bringing it into that market instead of spending it in other markets, - the meat, fish, fruit, or grocery markets, for instance. The abundance or scarcity of money for loan purposes is merely a sign or symptom of those more fundamental causes operating upon the rate of interest… In the present chapter we are content merely to point out that the theories of which it treats are crude and superficial. They contain a modicum of truth, but they do not reach the root causes of interest. It is true that explicit interest is dependent upon implicit interest; but this being so, the question still remains, What determines implicit interest? Again, it is true that the rate of interest, like every other ratio of exchange, depends on “supply and demand"; but the question, is, What constitutes the supply and demand? And again, it is true that interest varies with loanable funds; but what causes the variation of those funds?" (Italics and bold added)[2]

The fallacy is so evident that aroused the ire of Frank Knight who accused Keynes of committing a basic and foolish textbook mistake:

"Mr. Keynes bases his whole argument for the monetary theory of interest on the familiar fact that open market operations can be effective. Mr. Hicks makes the error more palpable by saying explicitly that new currency injected into an economy "at first" and "in the first instance" lowers the rate of interest, or discount, but afterwards raises prices and “therefore tends to increase discount.” But in his entire subsequent argument, Mr. Hicks assumes without qualification or reservation a definite (inverse) functional relation between the quantity of money and the interest rate. It is a depressing fact that at the present date in history there should be any occasion to point out to students that this position is mere man-in-the-street economics. The position is analytically absurd, and any respectable textbook in economics explains why. The rate of interest in its normal aspect as the rate of return on investment is the ratio between two value magnitudes, income and wealth. A change in the unit of value can affect this ratio only as it affects one of its terms more than it affects the other. There may (or may not) be such a differential effect for a time, after a monetary change. Of course if created currency is used exclusively to buy bonds, or even to construct new equipment, it can temporarily raise the relative price which the principal, or source, will yield. Such an occurrence is a temporary disturbance only. As a monetary change diffuses through the economy, it comes to affect all classes of prices in the same way, and at equilibrium any relative price will be the same as before the monetary change occurred –except in so far as in the meantime changes may have occurred in the factors which really control the price relation in question... That a monetary theory of interest should be defended by economists of repute is especially mysterious in view of the facts, which are directly contrary to what the theory calls for." (Italics and bold added) [3]

Please note that Fisher’s and Knight’s explanation assumes a uniform and proportional increment in prices as money increase, a phenomenon completely refuted by Mises (despite the fact that for those two “neoclassicals” the interest rate is affected first and before other prices are reached), but that does not affected the “essence” of their explanation.

And here is Mises:

"There were schools of thought for whom interest was merely a price paid for obtaining the disposition of a quantity of money or money substitutes. From this belief they quite logically drew the inference that abolishing the scarcity of money and money-substitutes would abolish interest altogether and result in the gratuitousness of credit. If, however, one does not endorse this view and comprehends the nature of originary interest, a problem presents itself the treatment of which one must not evade. An additional supply of credit, brought about by an increase in the quantity of money or fiduciary media, has certainly the power to lower the gross market rate of interest. If interest is not merely a monetary phenomenon and consequently cannot be lastingly lowered or brushed away by any increase, however large, in the supply of money and fiduciary media, it devolves upon economics to show how the height of the rate of interest conforming to the state of the market's nonmonetary data reestablishes itself. It must explain what kind of process removes the cash-induced deviation of the market rate from that state which is consonant with the ratio in people's valuation of present and future goods. If economics were at a loss to achieve this, it would implicitly admit that interest is a monetary phenomenon and could even disappear completely in the course of changes in the money relation… For this theory alone answers the question of how an inflow of additional money and fiduciary media affects the loan market and the market rate of interest. Only those for whom interest is merely the outgrowth of an institutionally conditioned scarcity of money can dispense with an implicit acknowledgment of the circulation-credit theory of the cycle. This explains why no critic has ever advanced any tenable objection against this theory." (Italics and bold added) [4]

Keynes’ theory was so wrong that it was refuted beforehand just some decades before by Mises himself. Here is The Lord:

"Interest today rewards no genuine sacrifice, any more than does the rent of land. The owner of capital can obtain interest because capital is scarce, just as the owner of land can obtain rent because land is scarce. But whilst there may be intrinsic reasons for the scarcity of land, there are no intrinsic reasons for the scarcity of capital. An intrinsic reason for such scarcity, in the sense of a genuine sacrifice which could only be called forth by the offer of a reward in the shape of interest, would not exist, in the long run, except in the event of the individual propensity to consume proving to be of such a character that net saving in conditions of full employment comes to an end before capital has become sufficiently abundant. But even so, it will still be possible for communal saving through the agency of the State to be maintained at a level which will allow the growth of capital up to the point where it ceases to be scarce." (Italics and bold added)[5]

I will totally pass over the obvious fact that Keynes (just like “Lord Keynes”) has just denied scarcity, to show what Mises responded to that in 1912:

"To one group of writers, the problem appeared to offer little difficulty. From the circumstance that it is possible for the banks to reduce the rate of interest in their bank-credit business down to the limit set by their working costs, these writers thought it permissible to deduce that credit can be granted gratuitously or, more correctly, almost gratuitously. In drawing this conclusion, their doctrine implicitly denies the existence of interest. It regards interest as compensation for the temporary relinquishing of money in the broader sense - a view, indeed, of insurpassable naivety. Scientific critics have been perfectly justified in treating it with contempt; it is scarcely worth even cursory mention. But it is impossible to refrain from pointing out that these very views on the nature of interest hold an important place in popular opinion, and that they are continually being propounded afresh and recommended as a basis for measures of banking policy." (Italics and bold added)[6]

and Fetter in 1927: 

"Interest was thought of as paid for the use of money, as land rent was paid for the use of land. But money "cannot breed money," as land can breed crops and feed flocks; money is the "barren breed of metal." Even to scholars, as well as to the populace, the price paid for the use of money (quite like that of other things) seemed to depend on the plenty or scarcity of the precious metals. Certainly this notion still is the natural, naive, popular view, coming to the surface again and again, as in the Greenback program of the 70's and 80's, in the Populist movement of the 90's, in many contemporary pamphlets sent for the enlightenment of academic economists by amateur reformers, and even promulgated by distinguished inventors and manufacturers, who are novices in economic theory." (Italics and bold added)[7]

If any doubts are left about “Lord Keynes”’ and Lord Keynes’ unrealistic Land of Cockaigne assumption, see this statement by Mises:

"Originary interest cannot disappear as long as there is scarcity and therefore action. As long as the world is not transformed into a land of Cockaigne, men are faced with scarcity and must act and economize; they are forced to choose between satisfaction in nearer and in remoter periods of the future because neither for the former nor for the latter can full contentment be attained."(Italics added)

In denying the existence of originary interest, keynesians deny scarcity. And saying that interest is just a monetary phenomenon is exactly like saying that Earth is flat.

Why did all this happened? According to LK, all this is a misunderstanding:

"Critics of my posts on the ABCT have simply misunderstood my critique. The non-existence of the natural rate of interest is one of the reasons why Hayek’s early business cycle theory is wrong. That critique applies to all Hayekian forms of the theory that use the natural rate, and even these Austrian critics are admitting this point." 

Now I must say that “critics of [his] posts on the ABCT have simply misunderstood [his] critique” because of his own writings! I have already shown in my post that he criticized the whole ABCT (not only “Hayek’s version”) because “it is using Wicksells natural rate”, so here we go again: 

“And Austrian business cycle theory (ABCT) also employs the Wicksellian concept of the natural rate of interest. With the invalidity of the concept clear, it follows that ABCT is also invalid. I will have more to say about this in future posts.”

Where is Hayek’s name or reference in the whole post from where I got that extract? 


In the post showing all “versions” of ABCT (Hayek’s included of course) he said:  

"They are all subject to these flaws: (1) They assume a single real natural rate that does not exist in a growing, money-using economy..."

This is a false statement in a double way: 1) Mises' fully development of ABCT is not based on a single natural rate. 2) About different versions of ABCT, LK has said that all they are subject to Sraffa critique of a single natural rate. He did not said that only Hayek’s “version” is subject to that critique. 

In other post “criticizing” ERE he said. 

"Yet ABCT requires a single natural rate of interest in the real world for the market/bank rate to coincide with, in order that we can avoid the cycle effects allegedly caused by ABCT."

Once again there is no signal of “Hayek’s version” of the ABCT in the whole post. He said that the whole theory requires a single rate. There is no reference to Hayek. He was forced to try to clarify that in the comment section: “ABCT, in the versions propouned by Mises (2009 [1953]: 349–366; Mises 2006 [1978]: 99ff.) and Hayek (1931) uses Wicksellian monetary equilibrium and the natural rate of interest concept.”
  

It must be obvious that in various occasions he said that all ABCT used one single-barter-Wicksellian rate and he did not clarify that he was referring to Hayek’s “version”. The “misunderstandings of his critiques” are, in some extent, LK’s own fault.  However I must say in his defense that he had clarified that his critiques apply to Hayek's "versions", or others that use "natural rate of interest in Wicksellian fashion", in many other occasions.

Let me end this post with an excellent quotation of Hazlitt: 

"No doubt Keynes's "system" owes part of its popularity to the impression that he has at last provided not only that Economics of Abundance, of which the Utopians have been dreaming from time immemorial, but has combined with it a Conspiracy Theory according to which the Moneylenders keep everything scarce in order that they may continue to receive Interest. But if everybody could have Complete Abundance of everything simply by ceasing to "keep capital scarce," then this Conspiracy must certainly be the most stupid and pointless in history. Did Keynes seriously believe all this?"[8]

PD: Just for the record, I did not say that Hayek’s presentation of ABCT is flawed. I think his reply is a total refutation of Sraffa’s evident misunderstanding of the theory he was trying to criticize. What I did was to show that misesian theory is totally immune to the italian critiques.

PD2: What about that marxists do not deny scarcity?

A quick search demonstrates that, starting with Marx himself, this is not totally true:

“In a higher phase of communist society” there will be so abundance that the society can “inscribe on its banners: From each according to his ability, to each according to his needs!” 
 
As Boettke and Leeson says:

"The socialists informed us that by rationalizing production and thus advancing material production beyond the bounds reachable under capitalism, socialism would usher mankind into a post-scarcity world… In short, the writings of Marx and other socialists were concerned (in part) with demonstrating the productive inferiority of the  capitalist system relative to what socialism could achieve.  The organization of production under capitalism still reflects the  “kingdom of necessity,” but the social  organization of production under socialism will deliver mankind into the “kingdom of  freedom” where, through rationalization of production, scarcity will be overcome."[9]

[1] Fetter, Frank A. The Principles of Economics, With Applications to Practical Problems (1905) page 19.

[2] Fisher, Irving. The Rate of Interest: Its Nature, Determination, and Relation to Economic Phenomena (1907) pages 8-9.

[3] Knight, Frank H. Selected Essays by Frank H. Knight, Volume 2: Laissez Faire: Pro and Con (1999) pages 143-44.

[4] Mises, Ludwig von. Human Action (1949) page 578.

[5] Keynes, John M. The General Theory of Employment, Interest and Money (1936) chapter 24. 

[6] Mises, Ludwig von. The Theory of Money and Credit (1912) page 353. 

[7] Fetter, Frank A. Capital, Interest and Rent: Essays in the Theory of Distribution (1977) page 260.

[8] Hazlitt, Henry. The Failure of the "New Economics" (1959) pages 233-34.

[9] Boettke, Peter J. and Leeson, Peter T. “Socialism: Still Impossible After All These Years” (2005)