1. Skip to navigation
  2. Skip to content
  3. Skip to sidebar
Source link: http://archive.mises.org/7650/last-knight-live-blog-21-kraus/

Last Knight Live Blog 21 – Kraus

January 14, 2008 by

Chapter 14, titled Booms, is a detailed and excellent narrative of a relatively short period of Mises’s life when he exercised strong intellectual influence and contributed significantly to the reemergence of free market ideas in Europe, particularly in Austria and Germany. At the London School of Economics, in persons of Professors Lionel Robbins and Friedrich von Hayek, Mises’s ideas had been given additional boost in the English speaking world.

During that time, Mises’s undeniable intellectual influence finally got him on the board of Verein für Socialpolitik, an association of German speaking economists. In addition, he was also extensively involved in the establishment and work of the Austrian Institute for Business Cycle Research that produced important studies advancing and spreading the word about Austrian theory of business cycles.

On the theoretical front, Mises formulated new directions in the theory of value and in monetary economics. It is on these two aspects of Mises’s work that I would like to comment in the following.
First, a short comment concerning an important detail in connection with Mises’s Irving Fisher’s proposal on monetary reform, which in its political dimension essentially pointed to a governmentally managed monetary system, with similar proposals offered by Keynes in his A Tract on Monetary Reform and other economists.

Mises devastated Fisher’s proposal on several junctures and showed that it was theoretically flawed as well as impracticable.

The principal argument for the reform was that for economies to function without both business fluctuations and major disturbances in the distribution of income between debtors and creditors, an elastic currency must be present to ensure stability of purchasing power of money. Incidentally, the essence of this argument has not lost any of its weight and continues to represent the final line of defense of those who see in central banking and the fractional reserve banking system indispensable institutions for promoting macroeconomic performance and maintaining price stability. To ensure stability of purchasing power a price index was to be worked out which would link the price of dollar currency not just to changes in the price of one commodity (gold under a gold standard) but to a set of different goods.

In the first place, Mises pointed to insurmountable difficulties in arriving on an objective standard for an index due to the existence of no objective standard for the importance of various goods that would be accounted for in such an index. Second, Mises tried to show that one of alleged major “evils” of unstable currency – the problem of unexpected shifts in the distribution of income between debtors and creditors, which would occur whenever the purchasing power of money changes, is entirely illusory.

While I agree with Mises’s overall conclusion that “unstable” currency based on the gold standard is not a problem, I tend disagree with one aspect of his analysis. Mises argued that so-called “price premiums” in the “gross interest rate” would usually take care of the alleged redistributive effect that failing (or rising) prices cause in the relation between debtor and creditor. I object to the analysis and argue that the doctrine of “purchasing-power-price premiums” leads directly to the erroneous conclusion that under conditions of rapid increases in productivity and falling prices, the “negative” premium would decrease or rather eliminate the rate of interest on the market for loanable funds. A zero rate interest on the loanable funds market in turn implies a stronger incentive to hold money rather than to invest it which, in turn, would reduce spending and incomes in the process. But this is a completely erroneous, and thus politically potentially dangerous, point of view.

In reality, decreasing or increasing commodity prices do not have any influence on the rate of profit, and thus on the interest on the market for loanable funds.

The reason Mises advocated the doctrine of “purchasing-power-price premiums” is that he, along with virtually all other Austrian economists up to the present with the sole exception of George Reisman, worked within the conceptual framework of Böhm-Bawerkian theory of interest (Prof. Reisman offers a thorough refutation of this theory in his book, Capitalism: A Treatise on Economics, pp. 792-797. See also his lecture on the same subject he delivered at the Mises Summer University in 2005.).

In a nutshell, the theory attempts to explain the category of interest, or, more precisely, the originary interest, on the basis of the relation between subjective values of present and future goods. The fundamental flaw in this theory is that it provides an explanation in terms of value while its actual purpose is to explain how the rate of interest is determined in terms of money. Böhm-Bawerk’s theory, as well as very similar nonmonetary theories of Irving Fisher and Frank Knight, is utterly incapable of explaining precisely because there is only calculation in terms of money. Unfortunately, nowhere in his writings did Mises develop a theory of interest in accordance with his own great discovery in the realm of economic calculation.

From what we have just seen, the theory of interest has an obvious connection to the theory of value, or, more accurately, the theory of economic calculation. The subject of my second comment is the relation between Mises’s calculation argument and Austrian subjective theory of value in general.

Prof. Hülsmann’s discussion of the development of Mises’s views on the theory of value confirms my own reading and understanding of Mises on that subject: his insight that there is no calculation in terms of value but only calculation in terms of money is indeed revolutionary. The problem is that Mises’s great insight is incompatible with almost everything the subjective theory of value of Menger and Böhm-Bawerk stands for. One economist at least, Friedrich von Hayek, did recognize the incompatibility when he wrote, without mentioning Mises by name, that:

Of course, in so far as one believes that a completely satisfactory solution to the problem [of imputation] has not yet been found, we cannot exclude the possibility from the very outset that the determinants of the prices of the factors of production are to be found in the exchange economy alone, and therefore that an imputation of value is not applicable, a view held by several younger authors. Nevertheless, if this view were regarded as valid, the result would be that we would have no satisfactory explanation of economic processes based on the subjective theory of value, and it would also follow that these authors too would lack any basis for many of their investigations. (cf. pp. 472-473 of Last Knight)

Hayek’s point is confirmed by Prof. Hülsmann in his summary of Mises’s views on the subject:

In contrast, other economists [than Mises] believed economic calculation was possible outside the framework of a market economy. They assumed that calculation in terms of market prices was only one form of economic calculation. More to the point, they believed that it was possible in principle for the members of society to perform calculation in terms of utility, which they assumed to be quantifiable. It followed that all elements of economic science–the science of calculated action–had the same general applicability as marginal value theory. Categories such as saving, consumption, capital, profit, loss, and efficiency were not just categories of the market, but of human action in general. (cf. ibid p. 596)

I think Hayek is exactly right: this view is diametrically at variance with almost everything the subjective theory of value, posed as the alleged true foundation of all of economic science, stands for. This is because one of central tenets of the subjective theory of value is that categories of saving, consumption, capital, profit, loss etc. will exist under any form of economic organization because they are eternal categories of human action. Mises, as late as in Human Action, taught, in perfect accordance with everything Menger and Böhm-Bawerk wrote on the subject before him, that, for example, the phenomenon of interest would be present even under socialism and as such is explainable by the alleged universal preference of present goods to future goods which, in turn, is implied by the very nature of human action itself. The same goes for all economic phenomena, that is, they all can and must be explained by the subjective theory of value as developed by Menger, Böhm-Bawerk and other champions of subjectivism in economics.

Mises could not free himself from the shackles of the subjective theory of value but he showed the way to construct a new and much more coherent theory of the market process. And this is one of the most significant pieces of information I have gained from reading The Last Kinght Of Liberalism. I hope that contemporary Austrian economists take this extremely important aspect of Mises’ work and its implications for economic theory in general more seriously.

{ 5 comments }

Peter January 15, 2008 at 10:08 pm

Who here is on LibraryThing?
http://www.librarything.com/work/4127091

André Dorais January 20, 2008 at 2:56 am

“Mises argued that so-called “price premiums” in the “gross interest rate” would usually take care of the alleged redistributive effect that failing (or rising) prices cause in the relation between debtor and creditor.”

This is false. Mises introduces the idea of “price premium” as a vain hypothesis needed to demonstrate the neutrality of money: “With neutral money, neutralization of the rate of interest could also be attained by another stipulation, provided the parties are in a position to anticipate correctly the future changes in purchasing power. They could stipulate a gross rate of interest containing an allowance for such changes, a percentile addendum to, or subtrahendum from, the rate of originary interest. We may call this allowance the—positive or negative— price premium. In the case of a quickly progressing deflation, the negative price premium could not only swallow the whole rate of originary interest, but even reverse the gross rate into a minus quantity, an amount charged to the creditor’s account. If the price premium is correctly calculated, neither the creditor’s nor the debtor’s position is affected by intervening changes in purchasing power. The rate of interest is neutral. However, all these assumptions are not only imaginary, they cannot even hypothetically be thought of without contradiction […]” http://mises.org/humanaction/chap20sec3.asp

Mr. Kraus is induced in error by Professor Reisman which, on page 795 of his book, puts both Irving Fisher and von Mises in the same bag for using the same concept. It is not because one is using a concept that he endorses what generally comes with it. On pages 792-7 which Kraus refers to, the time-preference theory is rejected on three counts, one of which is the supposed confusion among Austrian economists of not being able to differentiate between a quantity of goods and their worth in terms of money. This is a bogeyman from which, I think, Kraus builds his own misunderstanding:

“In a nutshell, the theory attempts to explain the category of interest, or, more precisely, the originary interest, on the basis of the relation between subjective values of present and future goods. The fundamental flaw in this theory is that it provides an explanation in terms of value while its actual purpose is to explain how the rate of interest is determined in terms of money.”

The purpose of the time-preference theory is not to determine the rate of interest in terms of money, but to provide an explanation of it. Mises links the theory of value, including the time-preference theory, to the theory of economic calculation while always differentiating both. Mr. Kraus thinks, along the lines of Prof. Reisman, that we must get rid of, or at least strongly modify, the time-preference theory because it involves an imputed and therefore subjective value. But instead of saying, like Prof. Reisman that Austrians do not differentiate between the quantity of goods and their related money worth, he leads us to a different sort of calculation, namely a utility calculus. It is not so much that he endorses such a calculus, although this is not clear from his commentary, rather it is to emphasize that there are numerous economists who are looking for ways to do without the time-preference theory because they “feel” it is incompatible with economic calculation. It is needless to say that a number does not prove anything.

Wladimir Kraus January 20, 2008 at 6:36 am


“Mises argued that so-called “price premiums” in the “gross interest rate” would usually take care of the alleged redistributive effect that failing (or rising) prices cause in the relation between debtor and creditor.”


This is false. Mises introduces the idea of “price premium” as a vain hypothesis needed to demonstrate the neutrality of money: “With neutral money, neutralization of the rate of interest could also be attained by another stipulation, provided the parties are in a position to anticipate correctly the future changes in purchasing power. They could stipulate a gross rate of interest containing an allowance for such changes, a percentile addendum to, or subtrahendum from, the rate of originary interest. We may call this allowance the—positive or negative— price premium. In the case of a quickly progressing deflation, the negative price premium could not only swallow the whole rate of originary interest, but even reverse the gross rate into a minus quantity, an amount charged to the creditor’s account. If the price premium is correctly calculated, neither the creditor’s nor the debtor’s position is affected by intervening changes in purchasing power. The rate of interest is neutral. However, all these assumptions are not only imaginary, they cannot even hypothetically be thought of without contradiction […]” http://mises.org/humanaction/chap20sec3.asp

The idea of price-premium is not merely a vain hypothesis but describes one of the components of gross rate of interest. One of the difficulties is that Mises’s analysis is interspersed with discussions of hypothesis containing imaginary or even contradictory elements. This makes it almost impossible to pin down what he exactly means. Nevertheless, he’s clear enough about the fact that such a premium is operative and regulates the height of the rate of interest when he writes, for example: “The increased propensity to buy or to sell, which generates the price premium, affects as a rule short-term loans sooner and to a greater extent than long-term loans.”
But let’s put aside this specific point and return the root of confusion – the time preference theory.


Mr. Kraus is induced in error by Professor Reisman which, on page 795 of his book, puts both Irving Fisher and von Mises in the same bag for using the same concept. It is not because one is using a concept that he endorses what generally comes with it. On pages 792-7 which Kraus refers to, the time-preference theory is rejected on three counts, one of which is the supposed confusion among Austrian economists of not being able to differentiate between a quantity of goods and their worth in terms of money.

The problem with the *conventional* time-preference theory (note: conventional because in Reisman’s own theory the concept of time-preference is a major component) is not that it is not “able to differentiate between a quantity of goods and their worth in terms of money”, whatever this means, but rather that the specific structure of this theory is not in position to explain the excess of money sales revenues over money costs of production on the basis of differences in value between present and future goods (which stand for factors of production). Böhm-Bawerk spends the greater portion of his treatise on the elaboration of precisely how the supposed undervaluation of future goods explains the systematic excess of money sales revenues over money cost of production. As Prof. Reisman showed, Böhm-Bawerk’s explanation in terms of subjective valuations of present goods as opposed to future goods is simply not in the position to explain how the rate of originary interest is determined in the market economy.


This is a bogeyman from which, I think, Kraus builds his own misunderstanding: “In a nutshell, the theory attempts to explain the category of interest, or, more precisely, the originary interest, on the basis of the relation between subjective values of present and future goods. The fundamental flaw in this theory is that it provides an explanation in terms of value while its actual purpose is to explain how the rate of interest is determined in terms of money.” The purpose of the time-preference theory is not to determine the rate of interest in terms of money, but to provide an explanation of it.

Please read what I actually wrote: “… it provides an explanation in terms of value while its actual purpose is to EXPLAIN HOW the rate of interest is determined in terms of money”. I know full well that a theory (!) cannot determine the rate of interest! How can a theory determine the rate of interest!? I know perfectly well that a theory can only explain the reality, not create it. Yes, and this is precisely the problem with Mises’s/Böhm-Bawerk’s theory: it fails to explain the phenomenon of originary interest without coming into contradiction with facts of reality. That’s all I wanted to convey.


Mises links the theory of value, including the time-preference theory, to the theory of economic calculation while always differentiating both. Mr. Kraus thinks, along the lines of Prof. Reisman, that we must get rid of, or at least strongly modify, the time-preference theory because it involves an imputed and therefore subjective value. But instead of saying, like Prof. Reisman that Austrians do not differentiate between the quantity of goods and their related money worth, he leads us to a different sort of calculation, namely a utility calculus.


It is not so much that he endorses such a calculus, although this is not clear from his commentary, rather it is to emphasize that there are numerous economists who are looking for ways to do without the time-preference theory because they “feel” it is incompatible with economic calculation. It is needless to say that a number does not prove anything.

First , where did I write, or even imply, that I’m leading the reader “to a different sort of calculation, namely a utility calculus?” In fact, I’m vehemently opposed to the notion of utility calculus, as I’ve repeatedly stated in my previous entries on The Last Knight. Second, the specific arguments against the conventional time-preference theory don’t have anything to with how many other economists “feel” about whatever. I’m stunned. Where did you get that I’m building my case on the opinion of the “numerous economists”? In fact, to my knowledge Prof. Reisman’s criticism, which I endorse, is unique in its specific content.

André Dorais January 20, 2008 at 12:58 pm

The acutal purpose of the time-preference theory is not to explain how the rate of interest is determined in terms of money; it explains the origin of the interest rate. The interest rate is first and foremost a general subjective preference for a present satisfaction over a future one. There is no money involve in this evaluation; only time. Money comes after; first as a translation of time and resources into money, second by adding the other risk components (purchasing power risk, project specific risk, etc.) to this basis i.e. the interest rate as each one’s time-preference.

When you say that Mises’ theory of time-preference contradicts the facts of reality you have in mind an incompatibility between a calculus in terms of money and a calculus in terms of subjective value, or more precisely time-preference value. But there is no contradiction. I admit that attributing a number to elapsing time sounds strange, but we do it all the time nevertheless. We exchange every day our resources, whether it is only our labour, against other resources represented by money.

Since you present this so-called contradiction as an opposition between a value and a calculation in terms of money, it is not clear whether your idea of value refer to a quantity able to be counted in mathematical terms or not. In this respect, I speculated to say that your view is somewhat different from what Prof. Reisman mentions : “The time-preference theory confuses the ratio of the present goods produced to the present-goods value of the factor of production used up to produce them, with the ratio of the monetary value of the present goods produced to the monetary value of the factors of production used up to produce them […] Both theories [productivity theory and time-preference theory] confuse the physical product with a monetary value […]”. Op cit p.794.

Since you present Hülsmann’s summary of Mises’ views as a confirmation of Hayek’s own doubts on the imputation theory and therefore also the subjective value theory and that these views refer to Friedrich von Wieser, Vilfredo Pareto and others, I thought myself legitimize in saying what I said.

Respectfully
AD

Wladimir Kraus January 20, 2008 at 1:18 pm

Thanks for your thoughtful comments! In the following I hope to convince you, or at least that you’ll give it more thought, of the essence of the problem of originary interest and what such a theory is absolutely obliged to deliver.

You state:

The acutal purpose of the time-preference theory is not to explain how the rate of interest is determined in terms of money; it explains the origin of the interest rate. The interest rate is first and foremost a general subjective preference for a present satisfaction over a future one. There is no money involve in this evaluation; only time. Money comes after; first as a translation of time and resources into money, second by adding the other risk components (purchasing power risk, project specific risk, etc.) to this basis i.e. the interest rate as each one’s time-preference.

Look, this is the basic problem. We observe the phenomenon of profit (originary interest) and want to explain why there’s a systematic excess of MONEY SALES REVENUES over MONEY COSTS OF PRODUCTION. Now, this problem is of an extreme importance because all economic actions are motivated by the profit motive, the essence of business cycles is that there’s a widespread decline in profitability, that business firms cannot sell their goods at prices that cover their costs, then there’s the problem of unemployment which, you’ll agree with me, is first of all the question from the standpoint of profitability to employ the workers etc., etc. Virtually all problems in economic theory are closely connected to the problem of profit/interest, and specifically in terms of money.

Böhm-Bawerk and other Austrians, essentially following his framework, offer a particular theory that attempts to explain this difference. How do they do that? They use the concept of time-preference which says that people value present goods more than future goods and this is served as the basis of the explanation of the EXCESS. But, as Prof. Reisman shows this explanation suffers from a number of shortcomings.

The question is really very simple: does it or does Böhm-Bawerk’s theory explain the phenomenon of the excess of money sales revenues over money costs of production. That’s really it!

Regards

Comments on this entry are closed.

Previous post:

Next post: