This is a continuation of the previous blog. So if you just walked in, scroll down a bit and get your bearings if need be.
Let us note first that Mises meant nothing personal when he said Keynes’ theory of interest should be treated with contempt. He wrote his dismissive opinion of it 12 years before Keynes published the General Theory; it was a well known idea long before Keynes decided it was the correct one.
OK, now let’s get to the one paragraph of Keynes that Bob Murphy quoted and called brilliant:
It should be obvious that the rate of interest cannot be a return to saving or waiting as such. For if a man hoards his savings in cash, he earns no interest, though he saves just as much as before. On the contrary, the mere definition of the rate of interest tells us in so many words that the rate of interest is the reward for parting with liquidity for a specified period. For the rate of interest is, in itself, nothing more than the inverse proportion between a sum of money and what can be obtained for parting with control over the money in exchange for a debt for a stated period of time.
There are two parts here, one disproving a different theory of interest [in two sentences], and one setting forth what Keynes considers the correct theory [in two sentences]. Which of the two halves is brilliant, or even right? The first, the second, both?
Interest cannot be a “return”, says Keynes. Here he is using return in the way it is used in the phrase “return on equity”. Dictionary.com in definition 17 for return has
reciprocation, repayment, or requital: profits in return for outlay.
So Keynes is saying that interest is not a profit or payment you get “to saving or waiting as such.” Because nobody pays you anything if you just sit there, money in wallet, and don’t spend your money for a year.
Hazlitt fifty years ago and Bob Wenzel yesterday pointed out that Keynes is disproving a twisted version of time preference theory, what is called attacking a straw man. Nobody ever said that interest is a reward you get for waiting. What they did say is that interest is what the other guy is willing to pay you for him not having to wait.
Let’s think about this in relation to a simpler case, selling a tomato. If I sell a tomato, I get paid. Keynes would say that you are not getting paid for losing your enjoyment of a tomato, because if a dog snatches it from you or it gets run over by a truck or you do nothing till it rots, you won’t get paid.
Yeah, we know that, thank you very much. Life is unfair. Nobody pays you because you were a good boy, or because you lost something. They pay you because there was something in it for them. If you get paid for a tomato, it is because they are so desperate to get the tomato they are willing to trade for it. They are willing to part with their hard earned cash to eat that luscious red juicy tomato.
Similarly, when I lend money at interest for a year, of course nobody is paying me because I will have to wait a year before I spend it. They are paying me because there is something in it for them to borrow that money and repay it with interest. To quote Popeye’s friend Wimpy, they will gladly pay me next Tuesday for a hamburger today.
|O Mighty Seer.|
Is Keynes saying Wimpy was lying? That he would not gladly pay interest next Tuesday for a hamburger today? Maybe, but he sure hasn’t proven that Wimpy is lying. Not only that, he hasn’t even acknowledged Wimpy’s existence. Keynes wrote that the lender is not getting paid for waiting, but forgot about the borrower [Wimpy] paying for not waiting.
OK, time to be fair. Yeah, I hate that, too. It seems, from reading Dr Murphy’s neglected dissertation, that there are two versions of time preference theory [=I’m paying to have my hamburger today]. One is an older version that seeks to explain interest rates as resulting from a combination of ingredients. Bohm-Bawerk, a pioneering Austrian economist, indeed wrote that one reason for interest is that things get more valuable over time, if you put in the work. To quote Doctor Murphy:
…This is seen most clearly in natural goods such as fruits
and herds of livestock. But it is also true (from an economic point of view) for
virtually all other consumption goods, since they can be produced with various
techniques, the more time-consuming of which will necessarily be more
So that maybe Keynes is attacking this piece of time preference theory. He would be saying that yes, you will get more in the future if you work with your money, but when you lend the money you are not going to work with it, obviously, because you no longer have it. You will lie in your hammock and smoke expensive cigars, dreaming of the extra 5 bucks you will get for free.
Uh oh. It does make sense, doesn’t it? And indeed later Austrians have also rejected this slice of Bohm-Bawerk’s theory. Sorry, I don’t know if they rejected it for Keynes’ reason or not.Maybe one of the readers can help us out by leaving a comment about this.
Of course, one would have to read more of Keynes’ book to see if he was being intellectually honest here or not. Because Bohm-Bawerk gave other reasons for the existence of interest, one of which has been accepted by later Austrians as being the correct one, Wimpy’s reason. Does Keynes bother with Wimpy on another page of his book? If so, well and good. If not, he was straw manning, citing one piece only of prevailing interest theory, refuting it, and pretending that he had refuted the whole theory. Again, comments that will fill this gap in my knowledge are appreciated.
One more thing. Did Murphy understand Keynes here the way I did? I’m not sure, but I doubt it. Dr Murphy seems to be presenting his own reasons why the standard Austrian theory of interest is lacking, as well as agreeing with Keynes that the five bucks of interest is reimbursement for the loss of liquidity.
Bottom line, I learned something, mainly that I’m in over my head. To really get what Dr Murphy is saying, you have to read his neglected dissertation [and to really get that, you have to dive into Human Action and other works].
The q of whether those first two sentences of Keynes hold water doesn’t seem important. Either he is attacking a straw man, or a portion of Austrian theory long discarded.