De-Homogenizing Mises and Hayek: Hayek Favors the Productivity Explanation of Interest Instead of the Fetter-Mises Subjectivist Theory

A major reason for the neglect of this model is that in the United States, where the Austrian School experienced a renaissance in the second half of the twentieth century, the scholars adopted the Fetter-Mises subjectivist theory of interest instead of a productivity theory. The time preference theory of interest was endorsed by Rothbard ([1962] 2009), Garrison (1979), Kirzner (1993), and other authors (see Pellengahr 1996). Hayek (1941), on the other hand, very explicitly chose the productivity explanation of interest, even though he thought that time preference could also play a (minor) role in the determination of interest.³¹ As a result, his model—interpreted by Hayek as a validation of the productivity theory of interest—was largely overlooked.

__________

³¹ “Of the two branches of the Böhm-Bawerkian school, that which stressed the productivity element almost to the exclusion of time preference, the branch whose chief representative is K. Wicksell, was essentially right, as against the branch represented by Professors F. A. Fetter and I. Fisher, who stressed time preference as the exclusive factor and an at least equally important factor respectively.” (Hayek 1941, 420)

—Renaud Fillieule, “The Macroeconomic Models of the Austrian School: A History and Comparative Analysis,” Quarterly Journal of Austrian Economics 22, no. 4 (Winter 2019): 558-559.

Hayek Admitted That His Business Cycle Theory Stands Or Falls On Sraffa’s Challenge to Forced Savings

The next problem concerned Hayek’s analysis of forced savings. Recall that in the Austrian theory of the cycle the lengthening of the structure of production, begun under a regime of forced savings, never gets completed. It is always the case that rising consumer prices signal firms that their earlier decision to employ more roundabout methods was in error. Firms abandon their incomplete capital projects and thereby precipitate the crisis. But isn’t it possible that the transition to more capital-intensive production methods could be completed in time? Might not the consumer goods produced by using more roundabout methods come onto line just as consumer demand begins to rise? In short, why must the traverse to a new structure of production always be interrupted before completion? 

Hayek admitted in his reply that “it is upon the truth of this point that my theory stands or falls.” And, sadly for Hayek, his insistence that the traverse could never be completed strikes many current commentators as being the chief deficiency of his theory of the cycle. The general consensus is that, while the scenario painted by Hayek is a possible one, he neither demonstrated its necessity nor gave adequate attention to the lags implicit in the process of adjustment that he portrayed. Hayek’s theory fits some, but not all, trade cycles: It is not, as Hayek purported it to be, a general theory of the cycle.

—Bruce Caldwell, ed., editor’s introduction to The Collected Works of F. A. Hayek, vol. 9, Contra Keynes and Cambridge: Essays, Correspondence, by F. A. Hayek (Indianapolis: Liberty Fund, 1995), 38-39.

De-Homogenizing Mises and Hayek: Hayek Believes that the Banks Are NOT “GUILTY” of Causing Business Cycles

There is another grave problem with Hayek’s 1933 analysis. He believes that the banks are not “guilty” of causing business cycles also because he thinks that in the early stages the “natural rate of interest” or profit on the market increases, and that the banks are not astute enough to realize it, so that they only pull the loan rate of interest below the natural rate, that is, by not raising their loan rates fast enough to match changes in the natural rate. The difficulty with this is that it misconceives the Misesian (1912) insight. The problem is not one of omission, rather it is one of commission; it is not that the banks are too passive and ignorant about finding the right loan rate to match the natural rate. Instead, it is that they actively expand credit beyond the cash in their vaults, thereby pushing the loan rate below the natural rate. In short, the Misesian view is that the banks don’t have to search for the natural rate in order to avoid generating the business cycle; all they have to do is not expand credit beyond their cash holdings. This is surely a much easier task. The banks’ insistence on expanding credit generates the business cycle, and makes them responsible and thus “guilty” as charged.

—Walter Block and Kenneth M. Garschina, “Hayek, Business Cycles and Fractional Reserve Banking: Continuing the De-Homogenization Process,” Review of Austrian Economics 9, no. 1 (1996): 83.

J. S. Mill Warns Us Against the Simplistic Incorporation of Derived Demands into Macroeconomic Theorizing

 John Stuart Mill’s cryptic aphorism, “Demand for commodities is not demand for labor,” warns us against the simplistic incorporation of derived demands into macroeconomic theorizing. Some such notion of derived demand, whereby the demand for final output and the demand for the factors of production always move in the same direction, characterizes virtually all modern macroeconomic theories. The recognition that the two demands can move in opposite directions characterizes the Austrian formulation and constitutes one of the most fundamental differences between the Austrian theory and its rivals. 

In accordance with Mill’s Fourth Proposition, a decrease in the current level of consumption does not necessarily mean a decrease in the demand for labor (and for other factors of production); a decrease in the current level of consumption may mean instead an increase in the level of saving, an increase in the level of future consumption, and a corresponding shift of resource demand away from the production for current-period consumption and toward the production for future-period consumption (Hayek 1941, pp. 433-39). There may even be a net increase in the current demand for capital and labor.

Hayek and other Austrian theorists have heeded Mill’s Fourth Proposition by recognizing that in a given period consumption spending and investment spending can—and, in conditions of full employment, must—move in opposite directions. In fact, it is the shifting of resources between consumption and investment activities—and between the different stages of the production process—in response to changing intertemporal consumption preferences that allows the economy to achieve intertemporal coordination. And it is the similar shifting of resources in response to monetary manipulations that constitutes intertemporal discoordination.

—Roger W. Garrison, “Hayekian Trade Cycle Theory: A Reappraisal,” Cato Journal 6, no. 2 (Fall 1986): 441-442.

Keynes Suggested that Hayek Was Trapped in an Old Framework in which Only Changes in Credit Could Cause Savings to Differ from Investment

For Keynes’s second claim was that Hayek had misunderstood in a fundamental way the thrust of the Treatise [on Money], and that many of Hayek’s criticisms were therefore misdirected. What Hayek had missed, according to Keynes, was the claim that savings and investment could “get out of gear” within the framework of the Treatise [on Money] for any of a number of reasons that were independent of changes in the amount of credit in the system. Keynes suggested that Hayek’s misreading was due to his being trapped within an old framework, one in which only changes in credit could cause savings to differ from investment. Exposing Hayek’s flawed framework was then Keynes’s excuse for reviewing Prices and Production. . . . 

But Keynes’s claims notwithstanding, many sources of disturbance were possible within Hayek’s model, too. One reason that Keynes may have missed this point is that he focused on Prices and Production, where the origins of the cycle take a back seat to the changes in the structure of production that constitute the cycle. In the fourth chapter of his earlier (and at that time available only in German) Geldtheorie und Konjunkturtheorie [Monetary Theory and the Trade Cycle], Hayek described things other than the actions of banks that could cause, in Keynes’s later terminology, the “marginal efficiency of capital” curve to shift. But Keynes was right to say that for Hayek, the effects of the shift will necessarily be transmitted through the credit system: It cannot be otherwise in a monetary economy.

—Bruce Caldwell, ed., editor’s introduction to The Collected Works of F. A. Hayek, vol. 9, Contra Keynes and Cambridge: Essays, Correspondence, by F. A. Hayek (Indianapolis: Liberty Fund, 1995), 29-30.

On the Böhm-Bawerkian Distinction Between “Originating Forces” and “Determining Forces” of Interest

 “Some writers,” Fisher wrote, “have chosen, for purposes of exposition, to postulate two questions involved in the theory of the rate of interest, viz., (1) why any rate of interest exists and (2) how the rate of interest is determined.” Fisher dismisses this distinction as being unilluminating, “since to explain how the rate of interest is determined involves the question of whether the rate can or cannot be zero.” The purpose of the present section of this paper is (a) to present the case for the distinction criticized by Fisher—a distinction in fact made by Böhm-Bawerk, as we shall see—and (b) to show how failure to understand the rationale for the distinction has generated the widespread modern bewilderment with PTPT [Pure Time-Preference Theory of Interest] referred to earlier.

No better defense for Böhm-Bawerk’s distinction need to be found than the lucid discussion that he himself provided. Böhm-Bawerk was criticizing Fisher for not distinguishing between “originating forces” and “determining forces.” “All interest-originating causes undoubtedly are also determining factors for the actual rate. But not all rate-determining factors are also interest-creating causes. . . . When we inquire into the causes of a flood we certainly cannot cite the dams and reservoirs built to prevent or at least mitigate inundations. But they are a determining factor for the actual water-mark of the flood. . . . Similarly, there are other circumstances besides the actual interest-creating causes that bring about or enhance the value advantage of present goods over future goods.”

—Israel M. Kirzner, “The Pure Time-Preference Theory of Interest: An Attempt at Clarification,” in Essays on Capital and Interest: An Austrian Perspective, ed. Peter J. Boettke and Frédéric Sautet, The Collected Works of Israel M. Kirzner (Indianapolis: Liberty Fund, 2010), 161.

Kirzner’s Defense of the Pure Time-Preference Theory of Interest Amounts to an Affirmation of “Methodological Essentialism”

It will be observed that our defense of PTPT [Pure Time-Preference Theory of Interest] against the bewilderment evinced by its various critics, amounts to a partial affirmation of what has sometimes been termed “methodological essentialism.” Several historians of thought have noticed that for Menger, economic science is a search for the reality underlying economic phenomena— for their essence (das Wesen). In a letter to Walras, Menger asks, “How can we attain to a knowledge of this essence, for example, the essence of value, the essence of land rent, the essence of entrepreneur’s profit . . . by mathematics?” This search for essences, reflecting a philosophical approach attributed to Aristotelian influence, would focus, then, not on the land rent paid for a particular parcel of real-estate in a particular year, but upon those essential features of land rent that would be common to all examples of the phenomenon. Similarly an essentialist approach to the interest problem as posed by Böhm-Bawerk would focus not on the list of elements which together determine specific interest rates, but on those elements upon which the interest phenomenon essentially depends, elements without which the phenomenon could in fact not exist. PTPT finds these essential elements for the interest phenomenon in time preference.

—Israel M. Kirzner, “The Pure Time-Preference Theory of Interest: An Attempt at Clarification,” in Essays on Capital and Interest: An Austrian Perspective, ed. Peter J. Boettke and Frédéric Sautet, The Collected Works of Israel M. Kirzner (Indianapolis: Liberty Fund, 2010), 163-164.

Economists Fall into the Error of Defining Capital As REAL CAPITAL, As an Aggregate of PHYSICAL THINGS

Böhm-Bawerk defined capital as the aggregate of intermediate products (i.e., of produced means of production) and in so doing was criticized by Menger. Menger sought “to rehabilitate the abstract concept of capital as the money value of the property devoted to acquisitive purposes against the Smithian concept of the ‘produced means of production.’” As early as his work on Socialism (1923), Mises emphatically endorsed the Mengerian definition. In Human Action he pursued the question even more thoroughly, though without making it explicit that he was objecting to Böhm-Bawerk’s definition. Economists, Mises maintained, fall into the error of defining capital as real capital, as an aggregate of physical things. This is not only an empty concept but one that has been responsible for serious errors in the various uses to which the concept of capital has been applied. 

Mises’s refusal to accept the notion of capital as an aggregate of produced means of production expressed his consistent Austrian emphasis on forward-looking decision-making. Menger had already argued that “the historical origin of a commodity is irrelevant from an economic point of view.” Later Knight and Hayek were to claim that emphasis on the historical origins of produced means of production is a residual of the older cost-of-production perspectives and inconsistent with the valuable insight that bygones are bygones. Thus, Mises’s rejection of Böhm-Bawerk’s definition reflects a thoroughgoing subjective point of view.

—Israel M. Kirzner, “Ludwig von Mises and the Theory of Capital and Interest,” in Essays on Capital and Interest: An Austrian Perspective, ed. Peter J. Boettke and Frédéric Sautet, The Collected Works of Israel M. Kirzner (Indianapolis: Liberty Fund, 2010), 139-140.

Many of the Criticisms Leveled Against the Austrian Theory of Capital and Interest Are IRRELEVANT When It Is Cast in Terms of FORWARD-LOOKING Decisions

Mises took Böhm-Bawerk to task for not recognizing that time should enter analysis only in the ex ante sense. The role time “plays in action consists entirely in the choices acting man makes between periods of production of different length. The length of time expended in the past for the production of capital goods available today does not count at all. . . . The ‘average period of production’ is an empty concept.” It may be remarked that here Mises identified a source of perennial confusion concerning the role of time in the Austrian theory. Many of the criticisms leveled by Knight and others against the Austrian theory are irrelevant when the theory is cast explicitly in terms of the time-conscious, forward-looking decisions made by producers and consumers.

—Israel M. Kirzner, “Ludwig von Mises and the Theory of Capital and Interest,” in Essays on Capital and Interest: An Austrian Perspective, ed. Peter J. Boettke and Frédéric Sautet, The Collected Works of Israel M. Kirzner (Indianapolis: Liberty Fund, 2010), 138.

In Mises’s View, Böhm-Bawerk’s Theory Failed to Do Justice to the Universality and Inevitability of Time Preference

Mises, while paying tribute to the “imperishable merits” of Böhm-Bawerk’s seminal role in the development of the time-preference theory, sharply criticized the epistemological perspective from which Böhm-Bawerk viewed time as entering the analysis. For Böhm-Bawerk time preference is an empirical regularity observed through casual psychological observation. Instead, Mises saw time preference as a “definite categorial element . . . operative in every instance of action.” In Mises’s view, Böhm-Bawerk’s  theory failed to do justice to the universality and inevitability of the phenomenon of time preference. 

—Israel M. Kirzner, “Ludwig von Mises and the Theory of Capital and Interest,” in Essays on Capital and Interest: An Austrian Perspective, ed. Peter J. Boettke and Frédéric Sautet, The Collected Works of Israel M. Kirzner (Indianapolis: Liberty Fund, 2010), 138.

To Understand Hayek’s “The Pure Theory of Capital” Is to Question the Relevance of Mainstream Economics

The protracted and interwoven development of Hayek’s capital theory and business cycle theory was set against the background of an intense rivalry between Hayek and Keynes in the 1930s. Hayek had seen that ‘an elaboration of the still inadequately developed theory of capital was a prerequisite for a thorough disposal of Keynes’s argument’ (Hayek, 1983, p. 46); and, in retrospect, he considered it an error of judgement that he had given no time to an immediate and studious critique of Keynes’s General Theory. So, in addition to serving Hayek’s own exposition of a monetary theory of business cycles, The Pure Theory of Capital serves to expose the fallacy of the central tenet of Keynes’s General Theory — one that sits firmly in the mainstream of modern economics — for a ‘direct dependence of investment on final demand’ (Hayek, 1983, p. 48). Yet, Hayek’s exposé remains generally ignored, with the effect that Keynesian demand management (macroeconomics) together with marginal analysis (microeconomics) remain the dominant instruments of economic analysis. The issues could scarcely be more important. To understand The Pure Theory of Capital is to question the relevance of mainstream economics.

—Gerald R. Steele, “Hayek’s Pure Theory of Capital,” in Elgar Companion to Hayekian Economics, ed. Roger W. Garrison and Norman Barry (Cheltenham, UK: Edward Elgar Publishing, 2014), 71-72.

What Will Happen to the Pure Interest Rate If People Were Certain that the World Would End in the Near Future?

There are other elements that enter into the determination of the time-preference schedules. Suppose, for example, that people were certain that the world would end on a definite date in the near future. What would happen to time preferences and to the rate of interest? Men would then stop providing for future needs and stop investing in all processes of production longer than the shortest. Future goods would become almost valueless compared to present goods, time preferences for present goods would zoom, and the pure interest rate would rise almost to infinity. On the other hand, if people all became immortal and healthy as a result of the discovery of some new drug, time preferences would tend to be very much lower, there would be a great increase in investment, and the pure rate of interest would fall sharply.

—Murray N. Rothbard, Man, Economy, and State with Power and Market, 2nd ed. of the Scholar’s ed. (Auburn, AL: Ludwig von Mises Institute, 2009), 444.

The Final Market Rates of Interest Reflect the PURE Interest Rate PLUS OR MINUS Entrepreneurial Risk and Purchasing Power Components

In the purely free and unhampered market, there will be no cluster of errors, since trained entrepreneurs will not all make errors at the same time. The “boom-bust” cycle is generated by monetary intervention in the market, specifically bank credit expansion to business. Let us suppose an economy with a given supply of money. Some of the money is spent in consumption; the rest is saved and invested in a mighty structure of capital, in various orders of production. The proportion of consumption to saving or investment is determined by people’s time preferences—the degree to which they prefer present to future satisfactions. The less they prefer them in the present, the lower will their time preference rate be, and the lower therefore will be the pure interest rate, which is determined by the time preferences of the individuals in society. A lower time-preference rate will be reflected in greater proportions of investment to consumption, a lengthening of the structure of production, and a building-up of capital. Higher time preferences, on the other hand, will be reflected in higher pure interest rates and a lower proportion of investment to consumption. The final market rates of interest reflect the pure interest rate plus or minus entrepreneurial risk and purchasing power components. Varying degrees of entrepreneurial risk bring about a structure of interest rates instead of a single uniform one, and purchasing-power components reflect changes in the purchasing power of the dollar, as well as in the specific position of an entrepreneur in relation to price changes. The crucial factor, however, is the pure interest rate. This interest rate first manifests itself in the “natural rate” or what is generally called the going “rate of profit.” This going rate is reflected in the interest rate on the loan market, a rate which is determined by the going profit rate.

—Murray N. Rothbard, America's Great Depression, 5th ed. (Auburn, AL: Ludwig von Mises Institute, 2000), 9-10.

Levying Income Taxes Causes a Shift to a Higher Proportion of Consumption and a Lower Proportion of Saving and Investment

There is another, unheralded reason why an income tax will particularly penalize saving and investment as against consumption. It might be thought that since the income tax confiscates a certain portion of a man’s income and leaves him free to allocate the rest between consumption and investment, and since time preference schedules remain given, the proportion of consumption to saving will remain unchanged. But this ignores the fact that the taxpayer’s real income and the real value of his monetary assets have been lowered by paying the tax. We have seen in chapter 6 that, given a man’s time-preference schedule, the lower the level of his real monetary assets, the higher his time-preference rate will be, and therefore the higher the proportion of his consumption to investment. The taxpayer’s position may be seen in Figure 86, which is essentially the reverse of the individual time-market diagrams in chapter 6. In the present case, money assets are increasing as we go rightward on the horizontal axis, while in chapter 6 money assets were declining. Let us say that the taxpayer’s initial position is a money stock of 0M; tt is his given time-preference curve. His effective time-preference rate, determining his consumption/investment proportion, is t₁. Now, suppose that the government levies an income tax, reducing his initial monetary assets at the start of his spending period to 0M′. His effective time-preference rate, the intersection of tt and the M′ line, is now higher at t₂. He shifts to a higher proportion of consumption and a lower proportion of saving and investment.

—Murray N. Rothbard, Man, Economy, and State with Power and Market, 2nd ed. of the Scholar’s ed. (Auburn, AL: Ludwig von Mises Institute, 2009), 916-917.

It Is Fallacious to Assume that the State Can Simply Add or Subtract Its Expenditures from that of the Private Economy

The breakdown of the economic system into a few aggregates assumes that these aggregates are independent of each other, that they are determined independently and can change independently. This overlooks the great amount of interdependence and interaction among the aggregates. Thus, saving is not independent of investment; most of it, particularly business saving, is made in anticipation of future investment. Therefore, a change in the prospects for profitable investment will have a great influence on the savings function, and hence on the consumption function. Similarly, investment is influenced by the level of income, by the expected course of future income, by anticipated consumption, and by the flow of savings. For example, a fall in savings will mean a cut in the funds available for investment, thus restricting investment.

A further illustration of the fallacy of aggregates is the Keynesian assumption that the State can simply add or subtract its expenditures from that of the private economy. This assumes that private investment decisions remain constant, unaffected by government deficits or surpluses. There is no basis whatsoever for this assumption. In addition, progressive income taxation, which is designed to encourage consumption, is assumed to have no effect on private investment. This cannot be true, since, as we have already noted, a restriction of savings will reduce investment.

Thus, aggregative economics is a drastic misrepresentation of reality. The aggregates are merely an arithmetic cloak over the real world, where multitudes of firms and individuals react and interact in a highly complex manner. The alleged “basic determinants” of the Keynesian system are themselves determined by complex interactions within and between these aggregates.

—Murray N. Rothbard, “Spotlight on Keynesian Economics,” in Strictly Confidential: The Private Volker Fund Memos of Murray N. Rothbard, ed. David Gordon (Auburn, AL: Ludwig von Mises Institute, 2010), 233-234.

The "Cyclically Balanced Budget" Was the First Keynesian Concept to be Poured Down the Orwellian Memory Hole

Originally, Keynesians vowed that they, too, were in favor of a “balanced budget,” just as much as the fuddy-duddy reactionaries who opposed them. It’s just that they were not, like the fuddy-duddies, tied to the year as an accounting period; they would balance the budget, too, but over the business cycle. Thus, if there are four years of recession followed by four years of boom, the federal deficits during the recession would be compensated for by the surpluses piled up during the boom; over the eight years of cycle, it would all balance out. 

Evidently, the “cyclically balanced budget” was the first Keynesian concept to be poured down the Orwellian memory hold, as it became clear that there weren’t going to be any surpluses, just smaller or larger deficits. A subtle but important corrective came into Keynesianism: larger deficits during recessions, smaller ones during booms. 

—Murray N. Rothbard, “Keynesianism Redux,” The Free Market 7, no. 1 (January 1989): 3.

Government Investment Is a Form of Socialism and Fascism Is Private Ownership Subject to Comprehensive Government Control and Planning

Yes, let the state control investment completely, its amount and rate of return in addition to the rate of interest; then Keynes would allow private individuals to retain formal ownership so that, within the overall matrix of state control and dominion, they could still retain “a wide field for the exercise of private initiative and responsibility.” As Hazlitt puts it,

Investment is a key decision in the operation of any economic system. And government investment is a form of socialism. Only confusion of thought, or deliberate duplicity, would deny this. For socialism, as any dictionary would tell the Keynesians, means the ownership and control of the means of production by government. Under the system proposed by Keynes, the government would control all investment in the means of production and would own the part it had itself directly invested. It is at best mere muddleheadedness, therefore, to present the Keynesian nostrums as a free enterprise or “individualistic” alternative to socialism.

There was a system that had become prominent and fashionable in Europe during the 1920s and 1930s that was precisely marked by this desired Keynesian feature: private ownership, subject to comprehensive government control and planning. This was, of course, fascism.

—Murray N. Rothbard, “Keynes’s Political Economy,” in The Rothbard Reader, ed. Joseph T. Salerno and Matthew McCaffrey (Auburn, AL: Mises Institute, 2016), 202-203.

The State Apparatus, the 4th Class of Society, Is a “Deus Ex Machina” External to the Market Guided by Scientific Philosopher Kings

To develop a way out, Keynes presented a fourth class of society. Unlike the robotic and ignorant consumers, this group is described as full of free will, activism, and knowledge of economic affairs. And unlike the hapless investors, they are not irrational folk, subject to mood swings and animal spirits; on the contrary, they are supremely rational as well as knowledgeable, able to plan best for society in the present as well as in the future. 

This class, this deus ex machina external to the market, is of course the state apparatus, as headed by its natural ruling elite and guided by the modern, scientific version of Platonic philosopher kings. In short, government leaders, guided firmly and wisely by Keynesian economists and social scientists (naturally headed by the great man himself), would save the day. In the politics and sociology of The General Theory, all the threads of Keynes’s life and thought are neatly tied up.

And so the state, led by its Keynesian mentors, is to run the economy, to control the consumers by adjusting taxes and lowering the rate of interest toward zero, and, in particular, to engage in “a somewhat comprehensive socialisation of investment.”

—Murray N. Rothbard, Keynes, the Man (Auburn, AL: Ludwig von Mises Institute, 2010), 50.

Only Continual Doses of New Money on the Credit Market Will Keep the Boom Going and the New Stages Profitable

We have seen that the reversion period is short and that factor incomes increase rather quickly and start restoring the free-market consumption/saving ratios. But why do booms, historically, continue for several years? What delays the reversion process? The answer is that as the boom begins to peter out from an injection of credit expansion, the banks inject a further dose. In short, the only way to avert the onset of the depression-adjustment process is to continue inflating money and credit. For only continual doses of new money on the credit market will keep the boom going and the new stages profitable. Furthermore, only ever increasing doses can step up the boom, can lower interest rates further, and expand the production structure, for as the prices rise, more and more money will be needed to perform the same amount of work. Once the credit expansion stops, the market ratios are reestablished, and the seemingly glorious new investments turn out to be malinvestments, built on a foundation of sand.

—Murray N. Rothbard, Man, Economy, and State with Power and Market, 2nd ed. of the Scholar’s ed. (Auburn, AL: Ludwig von Mises Institute, 2009), 1002.

Keynes Severed the Evident Link Between Savings and Investment, Claiming the Two Are Unrelated

There is a subset of consumers, an eternal problem for mankind: the insufferably bourgeois savers, those who practice the solid puritan virtues of thrift and farsightedness, those whom Keynes, the would-be aristocrat, despised all of his life. All previous economists, certainly including Keynes’s forbears Smith, Ricardo, and Marshall, had lauded thrifty savers as building up long-term capital and therefore as responsible for enormous long-term improvements in consumers’ standard of living. But Keynes, in a feat of prestidigitation, severed the evident link between savings and investment, claiming instead that the two are unrelated.

In fact, he wrote, savings are a drag on the system; they “leak out” of the spending stream, thereby causing recession and unemployment. Hence Keynes, like Mandeville in the early eighteenth century, was able to condemn thrift and savings; he had finally gotten his revenge on the bourgeoisie.

By also severing interest returns from the price of time or from the real economy and by making it only a monetary phenomenon, Keynes was able to advocate, as a linchpin of his basic political program, the “euthanasia of the rentier” class: that is, the state’s expanding the quantity of money enough so as to drive down the rate of interest to zero, thereby at last wiping out the hated creditors. It should be noted that Keynes did not want to wipe out investment: on the contrary, he maintained that savings and investment were separate phenomena. Thus, he could advocate driving down the rate of the interest to zero as a means of maximizing investment while minimizing (if not eradicating) savings.

—Murray N. Rothbard, “Keynes’s Political Economy,” in The Rothbard Reader, ed. Joseph T. Salerno and Matthew McCaffrey (Auburn, AL: Mises Institute, 2016), 199-200.

The Austrian Contribution Was to Posit the Deviation of the Market Rate from the Natural Rate as the CAUSE of the Trade Cycle

The price mechanism, then, coordinates economic activity. In a trade cycle, economic activity somehow becomes uncoordinated. In particular, in the crisis stage of the cycle an overproduction of capital goods exists. As such, any adequate theory of the cycle must explain how this situation of disequilibrium in this specific market arises. What keeps the interest rate from performing its coordinative function? 

Once again Wicksell’s framework proved helpful. Wicksell posited another interest rate, the ‘market rate of interest’. The market rate is influenced by banks’ lending activities and can differ from the natural rate: Specifically, it will fall below the natural rate whenever banks increase the amount of credit. Wicksell used the natural rate / market rate distinction to discuss movements in the general price level. The Austrian contribution was to posit the deviation of the market rate from the natural rate as the cause of the trade cycle. 

—Bruce Caldwell, ed., editor’s introduction to The Collected Works of F. A. Hayek, vol. 9, Contra Keynes and Cambridge: Essays, Correspondence, by F. A. Hayek (Indianapolis: Liberty Fund, 1995), 15.

The Assumption that Consumption and Investment Move in the SAME Direction Over the Business Cycle Is Fundamental to Keynesian Macroeconomics

Hayek emphasized the trade-off between consumption today and consumption tomorrow (via saving and investment today): “The physical quantity of consumer goods per capita can only be increased by consistently devoting a larger part of productive resources to capitalistic investment rather than to immediate consumption.” One can illustrate the trade-off by drawing a production possibilities frontier between consumption and investment, as Roger Garrison has done in his important work developing Hayekian macroeconomics, particularly in the book Time and Money. Although the trade-off derives directly from the assumption of scarcity, and is today taken for granted by economists in the context of growth theory, Hayek noted that it is implicitly denied by all those economists who “assume that the demand for capital goods changes in proportion to the demand for consumer goods.” The most prominent such economists in 1932 were the “underconsumption” theorists of economic depressions, including John Maynard Keynes in his Treatise on Money  of 1930, which Hayek cited in this connection. Keynes amplified the underconsumption theme in his General Theory of 1936. The assumption that consumption and investment move in the same direction over the business cycle (by contrast to the trade- off acknowledged in the analysis of long-run growth) has been fundamental to Keynesian macroeconomics up to the present day.

—Lawrence H. White, ed., editor’s introduction to The Collected Works of F. A. Hayek, vol. 11, Capital and Interest, by F. A. Hayek (Chicago: University of Chicago Press, 2015), xxi.

In Rothbard’s Opinion, Lionel Robbins’s Book Is Unquestionably the BEST Work on the Great Depression

Lionel Robbins’s The Great Depression is one of the great economic works of our time. Its greatness lies not so much in originality of economic thought, as in the application of the best economic thought to the explanation of the cataclysmic phenomena of the Great Depression. This is unquestionably the best work published on the Great Depression.

At the time that Robbins wrote this work, he was perhaps the second most eminent follower of Ludwig von Mises (Hayek being the first). To his work, Robbins brought a clarity and polish of style that I believe to be unequalled among any economists, past or present. Robbins is the premier economic stylist.

In this brief, clear, but extremely meaty book, Robbins sets forth first the Misesian theory of business cycles and then applies it to the events of the 1920s and 1930s. We see how bank credit expansion in the United States, Great Britain, and other countries drove the civilized world into a great depression.⁶²

Then Robbins shows how the various nations took measures to counteract and cushion the depression that could only make it worse: propping up unsound, shaky business positions; inflating credit; expanding public works; keeping up wage rates (e.g., Hoover and his White House conferences)—all things that prolonged the necessary depression adjustments and profoundly aggravated the catastrophe. Robbins is particularly bitter about the wave of tariffs, exchange controls, quotas, etc. that prolonged crises, set nation against nation, and fragmented the international division of labor.

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⁶²In Britain the expansion was generated because of the rigid wage structure caused by unions and the unemployment insurance system, as well as a return to the gold standard at too high a par; and in the United States it was generated by a desire to inflate in order to help Britain, as well as an absurd devotion to the ideal of a stable price level.

—Murray N. Rothbard, Strictly Confidential: The Private Volker Fund Memos of Murray N. Rothbard, ed. David Gordon (Auburn, AL: Ludwig von Mises Institute, 2010), 289-290.

According to Rothbard, Sir Ralph George Hawtrey Was One of the Evil Geniuses of the 1920s

Executive director and operating head of the Association with such formidable backing was Norman Lombard, brought in by Fisher in 1926. The Association spread its gospel far and wide. It was helped by the publicity given to Thomas Edison and Henry Ford’s proposal for a “commodity dollar” in 1922 and 1923. Other prominent stabilizationists in this period were professors George F. Warren and Frank Pearson of Cornell, Royal Meeker, Hudson B. Hastings, Alvin Hansen, and Lionel D. Edie. In Europe, in addition to the above mentioned, advocates of stable money included: Professor Arthur C. Pigou, Ralph G. Hawtrey, J.R. Bellerby, R.A. Lehfeldt, G.M. Lewis, Sir Arthur Salter, Knut Wicksell, Gustav Cassel, Arthur Kitson, Sir Frederick Soddy, F.W. Pethick-Lawrence, Reginald McKenna, Sir Basil Blackett, and John Maynard Keynes. Keynes was particularly influential in his propaganda for a “managed currency” and a stabilized price level, as set forth in his A Tract on Monetary Reform, published in 1923.

Ralph Hawtrey proved to be one of the evil geniuses of the 1920s. An influential economist in a land where economists have shaped policy far more influentially than in the United States, Hawtrey, Director of Financial Studies at the British Treasury, advocated international credit control by Central Banks to achieve a stable price level as early as 1913. In 1919, Hawtrey was one of the first to call for the adoption of a gold-exchange standard by European countries, tying it in with international Central Bank cooperation. Hawtrey was one of the prime European trumpeters of the prowess of Governor Benjamin Strong. Writing in 1932, at a time when Robertson had come to realize the evils of stabilization, Hawtrey declared: “The American experiment in stabilization from 1922 to 1928 showed that an early treatment could check a tendency either to inflation or to depression. . . . The American experiment was a great advance upon the practice of the nineteenth century,” when the trade cycle was accepted passively. When Governor Strong died, Hawtrey called the event “a disaster for the world.” Finally, Hawtrey was the main inspiration for the stabilization resolutions of the Genoa Conference of 1922.

—Murray N. Rothbard, America's Great Depression, 5th ed. (Auburn, AL: Ludwig von Mises Institute, 2000), 176-177.

Government CANNOT Act in the General Interest When It Controls the Supply of Money

Yet even if we assumed that government could know what should be done about the supply of money in the general interest, it is highly unlikely that it would be able to act in that manner. As Professor Eckstein, in the article quoted above, concludes from his experience in advising governments:

Governments are not able to live by the rules even if they were to adopt the philosophy [of providing a stable framework].

Once governments are given the power to benefit particular groups or sections of the population, the mechanism of majority government forces them to use it to gain the support of a sufficient number of them to command a majority. The constant temptation to meet local or sectional dissatisfaction by manipulating the quantity of money so that more can be spent on services for those clamouring for assistance will often be irresistible. Such expenditure is not an appropriate remedy but necessarily upsets the proper functioning of the market. 

—F. A. Hayek, “The Denationalization of Money: An Analysis of the Theory and Practice of Concurrent Currencies,” in The Collected Works of F. A. Hayek, vol. 6, Good Money, Part II: The Standard, ed. Stephen Kresge (Indianapolis: Liberty Fund, 1999), 203.