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Americans determine US interest rates, not China or any other country.
In Joined at the Hip Thomas Friedman parroted the Krugman fallacy that US interest rates are being determined byChina’s trade surplus with the US (New York Times, 20 July 2005 ). According to this line of thought the US trade deficit with China has forced down US interest rates. This in turn has had the beneficial effects of promoting growth and stimulating the housing Market.
Ergo! All a country needs to do to generate growth and put its citizens’ in their own homes is to run a trade deficit with China – and the bigger the better. Of course, as soon as we puts it this way any normal person would immediately smell a rate. Unfortunately there seems to be very few normal people at the New York Times.
Friedman would counter that the ‘experts’ have shown that the massive amount of dollars that China has acquired have been invested in US bonds and that these purchases have raised bond prices and so lowered US interest rates, the effects of which have spread throughout the US economy.
Americans determine US interest rates, not China or any other country. Two things are missing here: a) any idea of the nature of the real determination of interest rates, b) monetary policy.
Interest, as the Spanish economist Faustino Ballvé succinctly put it, is the price of time. This is why future goods are discounted. This discount rate (interest) is determined by the social rate of time preference, i.e., aggregated individual time preference scales. (See The nature of interest rates and why it’s dangerous to manipulate them).
It is no secret that monetary policy can be used to manipulate interest rates – and is. In a nutshell: Operating through the banking system the central bank artificially lowers interest rates by expanding credit. As a rule this stimulates investment and housing. It also leads to balance-of-payments problems as the inflating country begins to run a trade deficit with its trading partners.
If this explanation holds then changes in the money supply would correlate, after a time lag, with changes in the mortgage rate. The Austrian school’s approach defines the money supply as cash plus demand deposits with commercial banks and thrift institutions plus saving deposits plus government deposits with banks and the central bank.
Plotting the US mortgage rate from 1990 to the present we find that changes in the rate are preceded by changes in the money supply as defined by Austrians. When money supply tightens rates go up and vice versa. This relation still held despite the fact that China pegged the Yuan at 8.276 to the dollar in 1994. Friedman and his experts are clearly looking the wrong way.
Toeing the orthodox line, Friedman concludes that if the dollar was heavily devalued this would force US interest rates up and the send the country into recession. Therefore this calamity can only be averted if China “continue holding our devaluing dollars and … keep US interest rates low”.
Friedman is contradicting the theory. China is not holding US dollars — it is holding US assets, many of which are T-bonds. Exports are the price of imports. So when China exports to the US it gets something in return. Most students of economics would sagely nod their heads at this insight, saying: “What they are getting are just little bits of green paper”. Not quite.
When China gets those little bits of green paper it uses them to buy US assets, whether they are T-bonds, hotels, factories or oil companies. In short, any US asset China buys with its dollars is in effect a US export. Hence the dollars return. Therefore it is not China ’s so-called dollar balances that are holding up the US currency because once these dollars come home, so to speak, they are no longer part of China ’s demand for dollars.
I am not denying that if China suddenly sold off its T-bonds, for example, that their price would not fall and so raise interest rates, only that this situation would reverse itself. After all, there is no point in China increasing its demand for dollars, which is what a T-bond sell off implies, unless it is going to use them to buy other US assets.
The real problem is the US money supply over which China has no influence whatsoever. Greenspan has driven down yields by injecting huge amounts of credit into the US economy. This is why at the end of May the yield on the 10-year T-note was 4 per cent as against 4.6 per cent for June 2004. The yield on Moody’s long-term AAA Corporate Bonds was about 5 per cent last May but 6 per cent June 2004.
The same monetary policy that has driven down rates has also been driving the trade deficit. To ‘credit’ Chinese exports with low US interest rates is to completely miss what the Fed has been doing.
Gerard Jackson is Brookes’ (http://www.brookesnews.com/index.html) economics editor. This article was first published in BrookesNews.com. Source: RiskCenter.com Gerard Jackson I frequently get letters from readers asking about the nature of interest and what the Austrian school has to say about it. To begin with, interest is not a reward for abstinence or owning capital, neither is it the price of money. Interest would still exist in the absence of capital and money. Committed Keynesians argue that Keynes' General Theory of Employment, Interest and Money (1936) contained two revolutionary propositions. (1) Interest is not the price that balances savings and investment, making a deficiency of aggregate demand possible. (2) Cutting wages to restore employment worsens the situation because it reduces purchasing power thus keeping the economy stuck in a deep depression. Ergo, only fiscal (printing money) policy can remedy the situation. Two things are very wrong here: first, the propositions were not revolutionary and, second, they were not new. But let us focus on interest. Now Keynes was hopelessly confused on the nature and role of interest. To him interest was a purely monetary phenomenon being determined by the supply and demand for money. This, however, is the same theory mercantilists used to explain the existence of interest and its rate. That Keynes should ascribe to the same theory in the light of the work done by Wicksell, Böhm-Bawerk, Fetter, Fisher, and von Mises really beggars belief. A proper understanding of interest is vital if we are to fully understand the consequences of Mr Keynes. In a truly great work (Capital and Interest) Böhm-Bawerk demolished the old interest theories and established the time preference theory as the correct theory of interest. However, his work has been virtually ignored by the neoclassical school whose explanation of interest assumes that it is really the producers' loan market that determines the rate of interest. This approach can be illustrated with supply and demand curves, the intersection of which determine the rate of interest. The supply curve is determined by time preference (the discount of future goods as against present goods) and the demand curve by the marginal efficiency of capital, i.e., the expected rate of return on investment. However, this approach completely ignores producers' gross savings and gives scant attention to the demand for present goods by owners of original factors. Moreover, producers are portrayed as just demanding present goods instead of supplying them through the use of future goods. Although the theory is superficial it is still a very plausible explanation. However, it makes the fundamental mistake of looking at the process as would a layman. After all, a businessman judges how much he will borrow according to his expected profit. Now most economists assume the existence of a range of investment possibilities, each with a different rate of return, say from 20 per cent to 5 per cent. It follows from this that if the rate of interest is 10 per cent the businessman will only borrow to finance projects that yield more than 10 per cent. Thus the most productive investments will be made first. These investments will become less and less value productive as they absorb more savings. Eventually the range of investment possibilities become exhausted and the rate of return settles at 10 per cent. It is this range of investment returns that it is claimed gives us the shape of the demand curve. It seems that what is being assumed here is that each dose of new investment yields a marginal value productivity, e.g., 20, 15, 12 per cent. Knowingly or otherwise, the theory is making the grave error of attributing value productivity to monetary investment. Now the theory rightly connects increases in physical productivity to investment. This, however, has nothing to do with the return on investment. For example, a firm produces 20 units per period for $X; investment in new processes increases its output to 100 units per period while increasing gross revenue by $2X. But this does not mean that value productivity increased by 100 per cent, because what benefits producers is the price margin between their selling prices and the sum of their factor prices and not gross revenue. The long-run tendency in the market is towards the equalisation of returns (price spreads) as entrepreneurs move to compete away profits. What the productivity theory calls a range of investments with different marginal productivity values is nothing more than a shelf of expected levels of profits. And profits are maladjustments between supply and demand. This means that in a truly profitable firm factors of production are actually paid less than the value of their marginal products. The difference is economic profit. The theory also contains another grave fallacy that we have already touched on. Keynesians insist that the rate of interest is determined in the producers' loan market. But as we have already seen, the 'normal rate of profit' (price spreads) is the rate of interest. Contract loans are only a reflection of that fact. Therefore the productivity of production processes have no bearing on the rate of interest. In the long-run, the rate of return (what some economists call normal profit) is not merely equal to the rate of interest it is the rate of interest, which in turn is determined by the social rate of time preference, that is, the sum of the time preference schedules of everyone in the economy. So even in the light of the fallacious neoclassical productivity theory of interest, which at least got it half-right (it uses time preference to explain the supply of savings), Keynes' monetary explanation takes a severe battering. It does not seem to have struck most Keynesians that by divorcing interest from the real economy by declaring it a monetary phenomenon they have accepted Keynes' reasoning that capital is not really scarce. Keynes made his belief in this absurd assumption clear when he stated that "there are no intrinsic reasons for the scarcity of capital" (375-76). This is an extraordinary statement for an economist to make. A world in which capital was not scarce, i.e., a free good, would be a world of superabundance — a land in which all consumer goods are literally free. Keynes just could not grasp that interest exists because people value present goods more than future goods (time preference). And so interest determines the supply of and demand for capital goods. It should be clear, however, that by equating the supply of capital goods with the demand for capital goods it is also allocating these goods through time. This equilibrating function is performed by what Knut Wicksell called the natural rate of interest. By using monetary policy to force the rate of interest to deviate from the natural rate, market rate, we generate booms and busts. The consequences of this knowledge for economic policy are enormous. Unfortunately such things are never raised within Australia's narrow intellectual confines. Now it cannot be said that Keynes was unaware of these remarkable developments in the theory of interest or even of the Austrian School which refined and comprehensively explored their ramifications. For example, he made a convoluted attack on time preference by asserting that von Mises' (a leading member of the Austrian school) "peculiar theory of the rate of interest" was "confusing the marginal efficiency of capital with the rate of interest" and that "Professor von Mises and his disciples have got their conclusions exactly the wrong way round" (p. 192-93). If Keynes had bothered to study the subject properly it would have become clear that the marginal efficiency of capital is the rate of interest. This is the natural rate of interest and a price on the time market. On p. 243 Keynes gave his readers a short and grotesque discussion on Knut Wicksell's concept of the natural rate of interest. It was clear that the concept was only raised so that he could give it a judicial execution, thus allowing himself carte blanche to carry the day with his own primitive and hoary theory dressed in new intellectual attire. He attacked Wicksell's concept by falsely claiming that "It is merely the rate of interest which will preserve the status quo." Now according to Wicksell the only thing the natural rate would preserve would be the existing level of prices; forcing the rate interest below its natural rate would only cause inflation and vice versa. Keynes unjust treatment of Wicksell was too much for even an adoring disciple like Hansen to take. In his Guide to Keynes he took him to task for his shabby treatment of Wicksell. In truth, Keynes was not a generous man to his opponents. It should now be clear that the Keynesian view that interest is the price of money has been totally discredited. As Mises put it (The Theory of Money and Credit, 1912): "It [the Keynesian view] regards interest as compensation for the temporary relinquishing of money in the broader sense. A view, indeed, of unsurpassable naivité. Scientific critics have been perfectly justified in treating it with contempt." He went on to say that such views "are continually being propounded afresh. . . ." Mises' book was published 24 years before the General Theory. Frank Knight was equally scathing about Keynes' views on interest, writing: "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" (On the History and Methods of Economics, 1952). So much for the Keynesian fallacy that interest is the reward for parting with liquidity. If interest is the price of anything, it is, as the Mexican economist, Faustno Ballvé, put it, the price of time (Essentials of Economics, 1963). Therefore, artificially lowering the rate of interest not only triggers the boom-bust cycle it can also reduce the level of real savings. Note: Unfortunately Bawerk later slipped back into a productivity theory of interest. Gerard Jackson is Brookes Economics Editor Source: RiskCenter.com The nature of interest rates and why it's dangerous to manipulate them
BrookesNews.Com
Wednesday 30 July 2003 
The nature of interest rates and why it's dangerous to manipulate them
Gerard Jackson
BrookesNews.Com
Wednesday 30 July 2003
I frequently get letters from readers asking about the nature of interest and what the Austrian school has to say about it. To begin with, interest is not a reward for abstinence or owning capital, neither is it the price of money. Interest would still exist in the absence of capital and money.
Committed Keynesians argue that Keynes' General Theory of Employment, Interest and Money (1936) contained two revolutionary propositions. (1) Interest is not the price that balances savings and investment, making a deficiency of aggregate demand possible. (2) Cutting wages to restore employment worsens the situation because it reduces purchasing power thus keeping the economy stuck in a deep depression. Ergo, only fiscal (printing money) policy can remedy the situation.
Two things are very wrong here: first, the propositions were not revolutionary and, second, they were not new. But let us focus on interest. Now Keynes was hopelessly confused on the nature and role of interest. To him interest was a purely monetary phenomenon being determined by the supply and demand for money. This, however, is the same theory mercantilists used to explain the existence of interest and its rate. That Keynes should ascribe to the same theory in the light of the work done by Wicksell, Böhm-Bawerk, Fetter, Fisher, and von Mises really beggars belief.
A proper understanding of interest is vital if we are to fully understand the consequences of Mr Keynes. In a truly great work (Capital and Interest) Böhm-Bawerk demolished the old interest theories and established the time preference theory as the correct theory of interest. However, his work has been virtually ignored by the neoclassical school whose explanation of interest assumes that it is really the producers' loan market that determines the rate of interest.
This approach can be illustrated with supply and demand curves, the intersection of which determine the rate of interest. The supply curve is determined by time preference (the discount of future goods as against present goods) and the demand curve by the marginal efficiency of capital, i.e., the expected rate of return on investment.
However, this approach completely ignores producers' gross savings and gives scant attention to the demand for present goods by owners of original factors. Moreover, producers are portrayed as just demanding present goods instead of supplying them through the use of future goods.
Although the theory is superficial it is still a very plausible explanation. However, it makes the fundamental mistake of looking at the process as would a layman. After all, a businessman judges how much he will borrow according to his expected profit. Now most economists assume the existence of a range of investment possibilities, each with a different rate of return, say from 20 per cent to 5 per cent.
It follows from this that if the rate of interest is 10 per cent the businessman will only borrow to finance projects that yield more than 10 per cent. Thus the most productive investments will be made first. These investments will become less and less value productive as they absorb more savings. Eventually the range of investment possibilities become exhausted and the rate of return settles at 10 per cent. It is this range of investment returns that it is claimed gives us the shape of the demand curve.
It seems that what is being assumed here is that each dose of new investment yields a marginal value productivity, e.g., 20, 15, 12 per cent. Knowingly or otherwise, the theory is making the grave error of attributing value productivity to monetary investment. Now the theory rightly connects increases in physical productivity to investment. This, however, has nothing to do with the return on investment.
For example, a firm produces 20 units per period for $X; investment in new processes increases its output to 100 units per period while increasing gross revenue by $2X. But this does not mean that value productivity increased by 100 per cent, because what benefits producers is the price margin between their selling prices and the sum of their factor prices and not gross revenue.
The long-run tendency in the market is towards the equalisation of returns (price spreads) as entrepreneurs move to compete away profits. What the productivity theory calls a range of investments with different marginal productivity values is nothing more than a shelf of expected levels of profits. And profits are maladjustments between supply and demand. This means that in a truly profitable firm factors of production are actually paid less than the value of their marginal products. The difference is economic profit.
The theory also contains another grave fallacy that we have already touched on. Keynesians insist that the rate of interest is determined in the producers' loan market. But as we have already seen, the 'normal rate of profit' (price spreads) is the rate of interest. Contract loans are only a reflection of that fact. Therefore the productivity of production processes have no bearing on the rate of interest.
In the long-run, the rate of return (what some economists call normal profit) is not merely equal to the rate of interest it is the rate of interest, which in turn is determined by the social rate of time preference, that is, the sum of the time preference schedules of everyone in the economy. So even in the light of the fallacious neoclassical productivity theory of interest, which at least got it half-right (it uses time preference to explain the supply of savings), Keynes' monetary explanation takes a severe battering.
It does not seem to have struck most Keynesians that by divorcing interest from the real economy by declaring it a monetary phenomenon they have accepted Keynes' reasoning that capital is not really scarce. Keynes made his belief in this absurd assumption clear when he stated that "there are no intrinsic reasons for the scarcity of capital" (375-76). This is an extraordinary statement for an economist to make. A world in which capital was not scarce, i.e., a free good, would be a world of superabundance — a land in which all consumer goods are literally free.
Keynes just could not grasp that interest exists because people value present goods more than future goods (time preference). And so interest determines the supply of and demand for capital goods. It should be clear, however, that by equating the supply of capital goods with the demand for capital goods it is also allocating these goods through time.
This equilibrating function is performed by what Knut Wicksell called the natural rate of interest. By using monetary policy to force the rate of interest to deviate from the natural rate, market rate, we generate booms and busts. The consequences of this knowledge for economic policy are enormous. Unfortunately such things are never raised within Australia's narrow intellectual confines.
Now it cannot be said that Keynes was unaware of these remarkable developments in the theory of interest or even of the Austrian School which refined and comprehensively explored their ramifications. For example, he made a convoluted attack on time preference by asserting that von Mises' (a leading member of the Austrian school) "peculiar theory of the rate of interest" was "confusing the marginal efficiency of capital with the rate of interest" and that "Professor von Mises and his disciples have got their conclusions exactly the wrong way round" (p. 192-93).
If Keynes had bothered to study the subject properly it would have become clear that the marginal efficiency of capital is the rate of interest. This is the natural rate of interest and a price on the time market.
On p. 243 Keynes gave his readers a short and grotesque discussion on Knut Wicksell's concept of the natural rate of interest. It was clear that the concept was only raised so that he could give it a judicial execution, thus allowing himself carte blanche to carry the day with his own primitive and hoary theory dressed in new intellectual attire.
He attacked Wicksell's concept by falsely claiming that "It is merely the rate of interest which will preserve the status quo." Now according to Wicksell the only thing the natural rate would preserve would be the existing level of prices; forcing the rate interest below its natural rate would only cause inflation and vice versa. Keynes unjust treatment of Wicksell was too much for even an adoring disciple like Hansen to take. In his Guide to Keynes he took him to task for his shabby treatment of Wicksell. In truth, Keynes was not a generous man to his opponents.
It should now be clear that the Keynesian view that interest is the price of money has been totally discredited. As Mises put it (The Theory of Money and Credit, 1912): "It [the Keynesian view] regards interest as compensation for the temporary relinquishing of money in the broader sense. A view, indeed, of unsurpassable naivité. Scientific critics have been perfectly justified in treating it with contempt." He went on to say that such views "are continually being propounded afresh. . . ." Mises' book was published 24 years before the General Theory.
Frank Knight was equally scathing about Keynes' views on interest, writing: "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" (On the History and Methods of Economics, 1952).
So much for the Keynesian fallacy that interest is the reward for parting with liquidity. If interest is the price of anything, it is, as the Mexican economist, Faustno Ballvé, put it, the price of time (Essentials of Economics, 1963).
Therefore, artificially lowering the rate of interest not only triggers the boom-bust cycle it can also reduce the level of real savings.
Note: Unfortunately Bawerk later slipped back into a productivity theory of interest.
Gerard Jackson is Brookes Economics Editor
Source: RiskCenter.com
The nature of interest rates and why it's dangerous to manipulate them
Gerard Jackson
BrookesNews.Com
Wednesday 30 July 2003
I frequently get letters from readers asking about the nature of interest and what the Austrian school has to say about it. To begin with, interest is not a reward for abstinence or owning capital, neither is it the price of money. Interest would still exist in the absence of capital and money.
Committed Keynesians argue that Keynes' General Theory of Employment, Interest and Money (1936) contained two revolutionary propositions. (1) Interest is not the price that balances savings and investment, making a deficiency of aggregate demand possible. (2) Cutting wages to restore employment worsens the situation because it reduces purchasing power thus keeping the economy stuck in a deep depression. Ergo, only fiscal (printing money) policy can remedy the situation.
Two things are very wrong here: first, the propositions were not revolutionary and, second, they were not new. But let us focus on interest. Now Keynes was hopelessly confused on the nature and role of interest. To him interest was a purely monetary phenomenon being determined by the supply and demand for money. This, however, is the same theory mercantilists used to explain the existence of interest and its rate. That Keynes should ascribe to the same theory in the light of the work done by Wicksell, Böhm-Bawerk, Fetter, Fisher, and von Mises really beggars belief.
A proper understanding of interest is vital if we are to fully understand the consequences of Mr Keynes. In a truly great work (Capital and Interest) Böhm-Bawerk demolished the old interest theories and established the time preference theory as the correct theory of interest. However, his work has been virtually ignored by the neoclassical school whose explanation of interest assumes that it is really the producers' loan market that determines the rate of interest.
This approach can be illustrated with supply and demand curves, the intersection of which determine the rate of interest. The supply curve is determined by time preference (the discount of future goods as against present goods) and the demand curve by the marginal efficiency of capital, i.e., the expected rate of return on investment.
However, this approach completely ignores producers' gross savings and gives scant attention to the demand for present goods by owners of original factors. Moreover, producers are portrayed as just demanding present goods instead of supplying them through the use of future goods.
Although the theory is superficial it is still a very plausible explanation. However, it makes the fundamental mistake of looking at the process as would a layman. After all, a businessman judges how much he will borrow according to his expected profit. Now most economists assume the existence of a range of investment possibilities, each with a different rate of return, say from 20 per cent to 5 per cent.
It follows from this that if the rate of interest is 10 per cent the businessman will only borrow to finance projects that yield more than 10 per cent. Thus the most productive investments will be made first. These investments will become less and less value productive as they absorb more savings. Eventually the range of investment possibilities become exhausted and the rate of return settles at 10 per cent. It is this range of investment returns that it is claimed gives us the shape of the demand curve.
It seems that what is being assumed here is that each dose of new investment yields a marginal value productivity, e.g., 20, 15, 12 per cent. Knowingly or otherwise, the theory is making the grave error of attributing value productivity to monetary investment. Now the theory rightly connects increases in physical productivity to investment. This, however, has nothing to do with the return on investment.
For example, a firm produces 20 units per period for $X; investment in new processes increases its output to 100 units per period while increasing gross revenue by $2X. But this does not mean that value productivity increased by 100 per cent, because what benefits producers is the price margin between their selling prices and the sum of their factor prices and not gross revenue.
The long-run tendency in the market is towards the equalisation of returns (price spreads) as entrepreneurs move to compete away profits. What the productivity theory calls a range of investments with different marginal productivity values is nothing more than a shelf of expected levels of profits. And profits are maladjustments between supply and demand. This means that in a truly profitable firm factors of production are actually paid less than the value of their marginal products. The difference is economic profit.
The theory also contains another grave fallacy that we have already touched on. Keynesians insist that the rate of interest is determined in the producers' loan market. But as we have already seen, the 'normal rate of profit' (price spreads) is the rate of interest. Contract loans are only a reflection of that fact. Therefore the productivity of production processes have no bearing on the rate of interest.
In the long-run, the rate of return (what some economists call normal profit) is not merely equal to the rate of interest it is the rate of interest, which in turn is determined by the social rate of time preference, that is, the sum of the time preference schedules of everyone in the economy. So even in the light of the fallacious neoclassical productivity theory of interest, which at least got it half-right (it uses time preference to explain the supply of savings), Keynes' monetary explanation takes a severe battering.
It does not seem to have struck most Keynesians that by divorcing interest from the real economy by declaring it a monetary phenomenon they have accepted Keynes' reasoning that capital is not really scarce. Keynes made his belief in this absurd assumption clear when he stated that "there are no intrinsic reasons for the scarcity of capital" (375-76). This is an extraordinary statement for an economist to make. A world in which capital was not scarce, i.e., a free good, would be a world of superabundance — a land in which all consumer goods are literally free.
Keynes just could not grasp that interest exists because people value present goods more than future goods (time preference). And so interest determines the supply of and demand for capital goods. It should be clear, however, that by equating the supply of capital goods with the demand for capital goods it is also allocating these goods through time.
This equilibrating function is performed by what Knut Wicksell called the natural rate of interest. By using monetary policy to force the rate of interest to deviate from the natural rate, market rate, we generate booms and busts. The consequences of this knowledge for economic policy are enormous. Unfortunately such things are never raised within Australia's narrow intellectual confines.
Now it cannot be said that Keynes was unaware of these remarkable developments in the theory of interest or even of the Austrian School which refined and comprehensively explored their ramifications. For example, he made a convoluted attack on time preference by asserting that von Mises' (a leading member of the Austrian school) "peculiar theory of the rate of interest" was "confusing the marginal efficiency of capital with the rate of interest" and that "Professor von Mises and his disciples have got their conclusions exactly the wrong way round" (p. 192-93).
If Keynes had bothered to study the subject properly it would have become clear that the marginal efficiency of capital is the rate of interest. This is the natural rate of interest and a price on the time market.
On p. 243 Keynes gave his readers a short and grotesque discussion on Knut Wicksell's concept of the natural rate of interest. It was clear that the concept was only raised so that he could give it a judicial execution, thus allowing himself carte blanche to carry the day with his own primitive and hoary theory dressed in new intellectual attire.
He attacked Wicksell's concept by falsely claiming that "It is merely the rate of interest which will preserve the status quo." Now according to Wicksell the only thing the natural rate would preserve would be the existing level of prices; forcing the rate interest below its natural rate would only cause inflation and vice versa. Keynes unjust treatment of Wicksell was too much for even an adoring disciple like Hansen to take. In his Guide to Keynes he took him to task for his shabby treatment of Wicksell. In truth, Keynes was not a generous man to his opponents.
It should now be clear that the Keynesian view that interest is the price of money has been totally discredited. As Mises put it (The Theory of Money and Credit, 1912): "It [the Keynesian view] regards interest as compensation for the temporary relinquishing of money in the broader sense. A view, indeed, of unsurpassable naivité. Scientific critics have been perfectly justified in treating it with contempt." He went on to say that such views "are continually being propounded afresh. . . ." Mises' book was published 24 years before the General Theory.
Frank Knight was equally scathing about Keynes' views on interest, writing: "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" (On the History and Methods of Economics, 1952).
So much for the Keynesian fallacy that interest is the reward for parting with liquidity. If interest is the price of anything, it is, as the Mexican economist, Faustno Ballvé, put it, the price of time (Essentials of Economics, 1963).
Therefore, artificially lowering the rate of interest not only triggers the boom-bust cycle it can also reduce the level of real savings.
Note: Unfortunately Bawerk later slipped back into a productivity theory of interest.
Gerard Jackson is Brookes Economics Editor
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