Hayek, Sraffa, Keynes, and the Natural Rate of Interest

For those unfamiliar with the Sraffa-Hayek debate, after the release of Prices and Production, Keynes tasked his Cambridge colleague Sraffa to write a critique of the book. In the end, Hayek lost the debate as he had to backtrack and concede to Sraffa’s points.

The most scathing blow Sraffa gave was his critique of Hayek’s conception of a natural rate of interest. This theory, which he took from the Swede, Knut Wicksell, states that there are two types of interest rates: the market rate of interest and the natural rate of interest. (Interest and Prices, p.102)

THERE is a certain rate of interest on loans which is neutral in respect to commodity prices, and tends neither to raise nor to lower them. This is necessarily the same as the rate of interest which would be determined by supply and demand if no use were made of money and all lending were effected in the form of real capital goods. It comes to much the same thing to describe it as the current value of the
natural rate of interest on capital

The money rate of interest is the interest rate we see in the finance market (bonds, stocks, etc.) while the natural rate is set by supply and demand in the real market. The latter is the interest rate neutral to commodity prices in the real market. According to Wicksell (and Hayek) the money rate ought to be equal to the natural rate to ensure price stability and avoid economic fluctuations.

Hayek went further with the natural rate of interest, theorizing that in a barter economy (an economy absent of currency), there would be one, unique, equilibrium interest rate that can be called the natural rate of interest.

Sraffa’s criticism was that such a conception of interest does not exist: (Dr. Hayek on Money and Capital, p. 51)

If money did not exist, and loans were made in terms of all sorts of commodities, there would be a single rate which satisfies the conditions of equilibrium, but there might be at any one moment as many “natural” rates of interest as there are commodities, though they would not be “equilibrium” rates.

There are in fact multiple natural rates of interest in a barter economy so it would be impossible for Hayek (or Wicksell) to use a central bank tool that targets a natural rate of interest.

Sraffa shows that in a barter economy, loans are made in terms of certain commodities (e.g., apples) and for each commodity there would be a different, corresponding one that would be it’s own-rate of interest, a rate defined in physical terms. To use an example by Robert Murphy, if one present could be exchanged for 2 claims to future apples, this exhange rate is the own-rate of apples. (A Problem With the Pure Time Preference Theory of Interest, p. 4).

The own-rate for any commodity would equal the ratio of the present quantity to the future quantity of that commodity in terms of another commodity. There would be multiple own rates for each commodity and they would fluctuate in response to the changing demands of a growing economy, therefore there can be no single natural rate of interest, an array of them. (The Sraffa-Hayek Debate on the Natural Rate of Interest, Glasner and Zimmerman, p. 3)

While these own rates would be equal in a static equilibrium, Sraffa argued that, in a growing economy in which relative prices were changing, the own rates would diverge, making it impossible to attach any definite meaning to the Hayekian notion of a unique natural rate of interest defined by pure barter relationships

When Pure Theory came out, Hayek conceded his earlier theory of interest… By adopting that of Keynes laid out in his General Theory:

The interest rate concept of Hayek is at least in its final version of The Pure Theory of Capital [is] not the same concept anymore which attracted criticism from Sraffa. Instead, the marginal rate of productivity employed by Hayek is not a physical rate of productivity but rather a price valued rate of productivity. This implies that the marginal rate of interest is not some physical rate of interest or own-rate of interest in its own commodity but equal to Keynes’s concept of an own-rate of interest in money terms.

Keyne’s addressed the Hayek-Sraffa debate in his magnum opus, but despite the fact that he assigned Sraffa to debate Hayek, he ended up taking the Austrian’s side. The two were able to resolve Sraffa’s critique by obersving that: (Goodspeed, Rethinking The Keynesian Revolution, p. 105)

So long as there are different rates of return that can be obtained by investing different units of input for a given period, it will be advantageous to effect the corresponding changes to the composition of inputs so as to go on increasing the total size of the associated output stream. ‘Hence,’ he notes, ‘the condition for maximising the total income stream … is that this rate of increase of the product due to an extension of the investment period by a given interval shall be the same for all investments…

The value equivalents of any two commodities in terms of another commodity at [two discrete dates] must bear the same ratio to one another, even though, as Hayek is keen to point out, the actual numerical value of this ratio will vary depending upon which commodity among many is selected as the numéraire.

This Wicksellian connection can be proven useful in augementing the Austrian Business Cycle. In one of my previous blog post, I laid out a plan to synthesize the Austrian theory with other business cycle theories, one of them being that of the post-Keynesian, Hyman Minsky. By using this Hayek-Keynes theory of interest, economist Frank Felgendreher synthesized Hayek’s business cycle theory with that of Hyman Minsky.

I still think there’s room for incorporating Monetary Disequilibrium Theory into this picture. In the future, I’ll see how it can be integrated into the work laid out by Felgendreher.

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Was Hayek a Keynesian and Mises a Monetarist?

Okay sorry for the clickbait but let me restate the title more accurately. Was Hayek more of a Post-Keynesian than a Monetarist. Secondly, was Mises more like the Monetarists than Hayek?

First of all, they are both Austrian economists. However they have some differences, most are not particularly important though. Some of their differences, like in methodology, are. The issue I wanna look at here is how they viewed the money supply.

Now we all know Hayek and Mises had disagreements with both Monetarists and Keynesians (Post-Keynesians no less) on this subject. However, Hayek is sometimes seen as being more compatible with monetarism due to his association with Milton Friedman, and also because he (supposedly) is a lot more accepting of neoclassical economics than was Mises.

But (when it comes to money at least) what if I were to say that Hayek is actually completely antithetical to Friedman and the monetarists. In fact, it is Mises’ thought that shares fundamental commonalities with the Chicago school that are nonexistent in Hayek.

First, some context.

It’s the 1930’s and a young FA Hayek at LSE is writing his major contributions to economic theory, Prices and Production (1932) and Profits, Interest, and Investments (1939). After losing a debate with Pierro Sraffa, most of his major followers will go on to be among the most prominent economists of the 21st century (John Hicks, Lionel Robbins, and Nicholas Kaldor) but by carrying the banner of the Keynes.

However, what did Hayek say about the supply of money and the shape of its curve in these works? I’ve talked about this in a different post but to reiterate (Cottrel, Hayek’s Early Cycle Theory Re-examined, pg. 9):

Hayek counts his own monetary theory of the cycle as an endogenous theory: the claim is that shifts in expected profitability… inevitable in the development of a capitalist economy, while the money rate of interest necessarily (under the current arrangements) fails to act as an adequate shock absorber in the face of these shifts…

His basic argument is that even in the absence of central bank accommodation,
the private banks will generally be in a position to extend their lending (and hence create deposits) at an unchanged rate of interest, in the face of increased loan demand from optimistic entrepreneurs.

Hayek saw the supply of money as endogenous. In fact, Larry White points out that Hayek believed the supply of money was a perfectly elastic, horizontal curve. (White, “Why Didn’t Hayek Favor Laissez-Faire in Banking?” History of Political Economy pg. 756)

By contrast, the monetarists were the exact opposite. They believe that the money supply was wholely exogenous and that the supply curve (in the long run) is a perfectly inelastic, vertical curve.

So Hayek believed in the exact opposite of the monetarists, but you know who did share the same conception of the supply of money? That’s right, Ludwig von Mises.

On the other hand, who believes like Hayek that the money supply is horizontal? The Post-Keynesians of course, you’ve already read the title of this blog post.

But seriously,  Louis-Philippe Rochon even explains that the Post-Keynesian economists Joan Robinson and Richard Kahn were influenced by Hayek in their attack against the monetarists in the 70-80s! (Rochon, Credit Money and Production, pg. 84)

The more you know…

Libertarian Discourse Ethics

Something most people don’t know (and I guess he doesn’t like mentioning it) is that Hoppe was actually a pupil of the Frankfurt School leader, Jurgen Habermas. The Frankfurt school is better known on the interwebs as the “Cultural Marxists.”

First, a quick digression. Anyone else thinks its funny the (alt-)right refers to Postmodern and Frankfurt philosophers as the same vein of “Cultural Marxists” even though Habermas believed in the spirit of the Enlightenment while Postmodernists staunchly stood against it? Well, it certainly isn’t surprising. In their vocabulary, they treat modernity and post-modernity interchangeably, just watch a Paul Joseph Watson video to see what I mean. It’d be nice if they recognized the difference between a modernist like Habermas and a postmodernist like Foucault. The former stark criticisms of the latter movement. (See Modernity vs Postmodernity or The Philosophical Discourse of Modernity)

Enough of that, I just been dying to say that for a long time now. Back to the point, what’s the point of this factoid? Well, Hoppe is very famous for developing Argumentation Ethics, a value-free logical proof of self-ownership that justifies a libertarian (Rothbardian) society. Readers who are familiar with Habermas already know where Hoppe got this idea from, the former’s similarly named Discourse Ethics.

I’m not going to explain them or go deep into what I agree and disagree with. To briefly put it, I think the criticism leveled against Hoppe by Bob Murphy and David Friedman is enough to dismiss Argumentation Ethics.

As for Habermas, his project finds the same pitfalls as did Kant’s categorical imperative (whom he’s trying to save) by being too abstract; particularly it’s too embedded with the impracticality of an ideal speech situation. And secondly, it also suffers from its dependency on speech act theory developed by the logical positivists, whose philosophical movement has been completely abandoned and referred to as a dark era in the Analytical tradition.

However, I think that Merleau-Ponty can offer us a discourse ethic by his philosophy of the flesh. Here, communicative rationality is possible not through detached abstractions, but by the embodied natured shared by man. Furthermore, this ethic would support a libertarian polity.

I know I’ve written about this in the past, however, those essays were always meant to be working papers. This project, to construct a libertarian discourse ethic through Merleau Ponty’s phenomenological existentialist philosophy, will take several steps and this is how I plan on going about doing it.

First I need to revise spelling/grammar mistakes in my Existentialist Contractualist and Ethics for Libertarian Existentialism essays. Sorry, I need to start peer reviewing more.

But more seriously, these two essays are gonna serve as the launchpad for this project. For the most part, I still hold on to what I said in those articles but there’s a lot of things that I felt were missing and I didn’t learn what they were until now.

Take the section on Law in my Contractualist essay for example.

It’s really short.

And more importantly, I tried to ground a Hayekian conception of law on Existentialist grounds and it just bluntly comes off as a forced leap. But it’s not necessarily that I was wrong for trying to do so, I just didn’t know what the missing link was to justify it.

That link is Edmund Burke. In this project, I’ll show how both Burke’s and the Existentialists view of man are the same, or at least similar, and this will serve in justifying a spontaneous order society.

I also want to go further and show how this will also justify a polycentric legal order as well. But to do this, it’ll first require completing an existentialist discourse ethics and from there, I’ll pull ideas on consent from polycentric theorist Tom W Bell and connect the two together. Which should be fairly easy, consent plays a (the?) central role in discourse.

The discourse ethic will also prove useful for strengthening my Ethics essay. I never found my “imperative for others” argument that convincing, having a solid discourse ethic should cement existentialist ethics as being universalist.

I also need to pull more from William Irwin’s, Free Market Existentialist. I only cited him only once or twice in my Contractualist essay and that was unacceptable. I have someone who has already done what I’m doing and I hardly used it. I mostly ignored his work because he justifies a libertarian society on mostly Sartrean grounds but his interpretation of Sartre can be reinterpreted in the eyes of a Pontyian.

I also need to consider de Beauvoir and her work, The Ethics of Ambiguity. She was the only existentialist of the 20th-century group to actually write a book on ethics and because of my prejudice against her, because she’s a feminist, I’ve ignored it. However, I think it could prove very useful as her ideas on the Other and ambiguity are closer to Ponty than they are to Sartre.

Funny enough, I have this book called Existentialist Thinkers and Ethics, which has an essay on a Pontyian virtue-deontological synthesis ethics which I mainly used for mine, and right before it is a chapter on Beauvoir’s ambiguity ethics.

After this, I think I will try to revisit my first blog posts on phenomenology and Austrian Economics. Back then, I had too much Sartrean in me so I argued for a dualist approach to scientific methodology. Now, my views have changed as a Pontyian and I also want to bring in hermeneutics into the equation, specifically that of Gadamer, and its relation to Popper’s critical rationalism.

The end product should be creating a refined Hayekian-Austrian economics with a methodological individualism by synthesizing Hayek’s and Popper’s methodological individualism and falsificationism with Lachmann and Gadamer’s hermeneutics, and Ponty and Schutz’s phenomenology.

Austrian Econ Reading List

So I thought of putting together a list of books that would introduce someone with little to no experience with economics to the Austrian school. It’s not going to be a completely comprehensive list but enough to give more than a solid grasp. The list is meant to order each book by difficulty and intellectual order, with the very first being the least difficult and most logical, to begin with. I also subdivided them into four sections from ‘Beginner’ to ‘Master’ and included optional reading under each. I (unfortunately) have not read all the books on the list, I mostly included ones that I have read and took in suggestions from others. So here it is:

Beginner

Economics in One Lesson by Henry Hazlitt – The most well-known introduction book on Austrian economics and for good reason to. This is the best book on the beginner’s list as it introduces to not only Austrian conceptions of methodological individualism and inflation, but also general economic theories like free trade. Words cannot do this book justice, it was my very first economics book and through it, my thinking has been able to develop and mature. Hopefully, by the end of it, you should have a good idea of basic economics but with some Austrian elements sprinkled into it. (pdf)(Amazon)

Understanding Austrian Economics by Henry Hazlitt – After being introduced to economics in the general sense, we can move forward directly into what the Austrian school has to say. Hazlitt’s essay, in a historical approach starting with Carl Menger, gives a quick and easy overview of the essentials of Austrian economics. Namely, the time preference theory of capital, human action, and a critique of general equilibrium. He also provides a reading list but let’s just ignore that… (HTML)

Austrian Economics: A Primer by Eamonn Butler – Here we have a more comprehensive introduction to Austrian economics. Butler’s book explores Mises thought as the cornerstone of Austrian economics, in a non-theoretical way. It’s a good lucid read to give the reader an applied insight into Austrian economics without complex technicalities. This will be essential as we begin to segue way into the theoretical aspects of the Austrian school (pdf)(Mises Store)

An Introduction to Austrian Economics by Thomas Taylor – This book is a more rigorous introduction as it goes more in-depth in its topics of Austrian Economics. This short book gives a concise introduction to Austrian thinkers, business cycle theory, and Mises’ evenly rotating economy. (HTML)(EPUB)(PDF)(Mises Store)

Additional Reading:

The Essential Hayek by Don Boudreaux – A great introduction to the overall thought of Hayek. I included here since Boudreaux’s book also deals with Hayek’s political ideas but it does include the essential (no pun intended) economic positions posited by Hayek on spontaneous order, prices, the business cycle, and inflation. Filled with fun graphics as well, this free book is something novice will thoroughly enjoy. (PDF)(HTML)(Amazon) (Bonus: Videos)

Foundations of Austrian Economics by Israel Kirzner – Kirzner is a living legend in the Austrian school which is why I must strongly recommend reading his short book, Foundations of Austrian Economics. It includes important gems like a critique of conventional supply and demand theory, the importance of entrepreneurship, and a good historical analysis of the Austrian School. (EPUB)

What Has Government Done to Our Money? by Murray Rothbard – In most of his writings, Rothbard’s audience included the general public which is what makes him one of the most readable Austrian economists. Here he boils down his version of Austrian monetary economics (a continuation of Mises) to give a case for full reserve banking and ending the federal reserve. (PDF) (EPUB) (HTML) (Amazon)

Intermediate

Advanced Introduction to Austrian Economics by Randle Holcombe – The aim of this book should be to consolidate what you have learned already in the beginners’ section and now use it in context of textbook economics. The book itself was actually written for people already familiar with conventional Neoclassical/Keynesian economics but no understanding of Austrian economics, so you will be in the reverse position. Be prepared to familiarize yourself with mainstream terminology and diagrams. (Amazon)

Note: If you’re struggling or feel like you would, I recommend reading Murphy’s book mentioned below or any introductory textbook, or watching a video series like this one from ACDC or this from Khan Academy, or lastly you can take an economics course at your high school or college.)

Austrian Macroeconomics by Roger Garrison – In my view, Garrison is one of the greatest living Austrian economists of our time. This monograph gives an amazing diagrammatical description of Austrian macroeconomics against the Keynesian framework. Garrison gives a great description exposition of Hayek’s structure of production, the Austrian theory of interest, heterogeneous capital theory, and much more. Impressively, he pacts so much so well in just 43 pages! (PDF) (EPUB) (Mises Store)

The Use of Knowledge in Society by FA Hayek – This essay is the best introduction to Hayek’s direct writings. Here we find not the very basis of his economic thought, but of his entire philosophy. His theory of decentralized knowledge and spontaneous order explains why prices coordinate efficiently and how planned economies are doomed to failure. (HTML) (PDF)

Additional Reading

Lessons for the Young Economist by Robert Murphy – If you want to study mainstream macroeconomics through the lens of the Austrian school, Murphy perfectly does the job. Remember that this is a textbook. (PDF) (EPUB) (Mises Store)

Individualism and Economic Order by FA Hayek – If you want to read more essays like the Use of Knowledge, then you can find a great collection of essays of Hayek’s economic and social theories in this book. (PDF) (EPUB) (Amazon)

Advanced

Choice: Cooperation, Enterprise, and Human Action by Robert Murphy – This quite honestly one of my favorite Austrian books of all time. Murphy does an incredible job of condensing Mises’ thousand paged Human Action in roughly 300 pages! It is undeniably a must buy since Mises’ book is the magnum opus that inspired every modern Austrian economist. His book is very intimidating, complex, and technical; I admittedly have not been able to read it fully. That is why I am more than thankful for Murphy’s work here. To reiterate, you MUST BUY (Amazon).

A Monetary Policy Primer by George Selgin – A great web series of essays on money, I strongly recommend reading these simple yet advanced essays on what modern theorists in monetary policy get wrong. He talks about everything from what money is, the money supply, the price of money, interest rates, optimal monetary policy, a free market banking system, etc. Short, easy to follow, and put in a historical context, mostly of the recent Great Recession. (HTML)

Competition and Entrepreneurship by Israel Kirzner – Kirzner gives a Misesian account of capital theory. He attempts to correct the neoclassical view by stressing the importance of the entrepreneur and his “alertness,” multiperiod planning, and a reconstruction of a new price theory. (Amazon)

Capital and Its Structure by Ludwig Lachmann – Lachmann’s book stands out as it strongly goes against what Kirzner has to say about capital theory. While also more of Hayekian than a Misesian unlike Kirzner on this issue, Lachmann’s inspiration is also greatly inspired by Keynesian (or more specifically, post-Keynesian) thought on uncertainty in expectations. (PDF) (EPUB) (Mises Store)

Pure Time Preference Theory of Interest by Jeffrey M. Herbener – A collection of essays by Rothbard, Mises, Kirzner, Roger Garrison, and Frank Fetter that elucidates the Austrian position of time preference as the theory of interest. This book posits itself against the views that interest rates are the “cost of money,” “the price of abstinence,” or “an account of the productivity of capital.” (PDF) (EPUB) (Amazon)

Austrian Theory of the Trade Cycle and Other Essays by Richard Ebling – Here you’ll find a collection of essays by Hayek, Mises, Rothbard, and commentary by Kirzner on Austrian business cycle theory. (PDF) (EPUB) (Mises Store)

Additional Reading:

The Kaleidic World of Ludwig Lachmann by Roger Garrison – Lachmann was an Austrian renegade that greatly inspired many GMU economists like the late Don Lavoie and Steve Horowitz. His methodology of radical subjectivism stresses the uncertainty of the future. This had a major impact on his capital theory which stands in opposition to Kirzner’s, Garrison gives a great introductory review. (HTML)

An Essay on Capital by Israel Kirzner – More accurately, it’s four sub-essays on capital. Kirzner begins by examining Robbinson’s Crusoe to demonstrate a capital theory based on multiperiod planning and unfinished plans. He goes on in further essays to critique Frank Knight and pointing out problems in trying to measure “capital.” (PDF) (EPUB)

Man, Economy, and State by Murray Rothbard – I mentioned earlier how Murphy wrote Choice as a way to simplify Human Action for the average person. Well, Rothbard did the same thing, except it’s just as long as Mises’ book. I’ve only read a few select chapters from this book so I’m not really sure if it is necessary to read if you already have Choice. But if you’re interested, Murphy says if you got a whole month to spare, then open this big guy up. There’s also a free study guide. (HTML) (PDF) (EPUB)

Mastery

Time and Money by Roger Garrison – As you may know by now, mainstream economics tends to neglect the importance of capital on the macroeconomy, particularly in business cycle theories. Garrison gives a comparative analysis of the Austrian approach against Keynesian and monetarist frameworks. His analyzes three main things: the structure of production, scarcity, and the market for loanable funds. To model these, he uses Hayekian triangles, a production possibilities curve, and a supply and demand graph respectively. I’m particularly fond of this book because of Garrison’s treatment of monetarism, he treats it as something that’s incomplete and is actually compatible with Austrian economics. (Amazon)

Microfoundations and Macroeconomics by Steve Horowitz – Steve’s project are similar to that of Garrisons. It begins by critiquing mainstream negligence of an intertemporal capital structure and Horwitz goes on how capital theory plays a key role as the microeconomic foundations for macroeconomics. The remainder of the book turns principally on monetarism and Austrian economics. Similarly again, Horwitz contends that the two are complements and he tries to build a bridge between the monetarism of Leland Yeager and the Austrianism of FA Hayek. (Amazon)

Note: If you want to know more about Yeager’s monetarism and his monetary disequilibrium theory, read his essay here. It’s pretty short and very simple and easy to understand. I’m pretty sure someone with a basic understanding of macroeconomics would fully understand it

The Theory of Money and Credit by Ludwig von Mises – This book was Mises most important writing on monetary theory. It greatly influenced even monetarists like Leland Yeager. There are a lot of important things in this book, key ones are Mises’ Regression Theorem, a blueprint for a business cycle theory, and a case for free banking. This book is essential to understanding every major work in Austrian monetary theory. (HTML) (EPUB) (PDF) (Mises Store)

Note: Free study guide here

Money, Bank Credit, and Economic Cycles by Jesus Huerta de Soto – I consider de Soto and Hulsmann to be the top two Austrian economists in Europe right now. De Soto’s magnum opus is a great piece of scholarship in the Rothbardian tradition. His book gives a critique of fractional reserve banking, supporting full reserve banking instead. He also looks to reinvent the legal framework of the banking system based on ancient Roman and Medieval Britannic law. This was the first major book of Misesian-Rothbardian monetary theory and banking in the 21st century. (PDF) (EPUB) (Mises Store)

Prices and Production by FA Hayek – There’s not much that needs to be said, this is Hayek’s most famous work in the field of economics and arguably his magnum opus (It is said that The Pure Theory of Capital was meant to be). Here we find the first formalization of modern Austrian business cycle theory. It stands as one of the most challenging reads in Austrian literature. (PDF) (EPUB) (Mises Store)

Human Action by Ludwig von Mises – Now the last book on our list. Mises’ magnum opus is what help set the Austrian school of thought from its contemporaries at his time. We find everything here including an exposition of methodological individualism and praxeology, a critique of socialist economic calculation, theories of interest, money, and business cycle, and just so much more. Literally, every subject is covered in Human Action which is what makes it, arguably, the greatest book on Austrian economics of all time. (HTML) (PDF) (EPUB) (Mises Store).

Note: Free study guide available here

Additional Reading

Money Free and Unfree by George Selgin – Selgin gives an account of monetary history blaming the federal reserve and other statist interventionism in our banking system as the culprit of economic fluctuations. At the time of the writing of this post, I have thoroughly enjoyed his book. Although it’s filled with many charts and graphs, Selgin gives a very well put, compact analysis. (Amazon)

The Midas Paradox by Scott Sumner – Although a ‘market monetarist,’ Sumner’s magnum opus on the history of the Great Depression has enjoyed great reviews by Austrian economists of both the Rothbardian and Hayekian tradition like Bob Murphy and Roger Garrison respectively. (Amazon)

America’s Great Depression by Murray Rothbard – If you’re looking for something more Austrian on the Great Depression, definitely check out Rothbard’s analysis. (PDF) (EPUB) (Mises Store)

The Pure Theory of Capital by FA Hayek – This was Hayek’s last major work on economics. I’m pretty sure he said that he left unfinished. It’s shorter than prices and production but also much more difficult as Hayek gets very technical in trying to make capital relevant to the analysis of monetary phenomena. It’s an important book but also a very hard one to get through. If you feel like you can handle it, take your shot. (PDF) (Mises Store)

Popper and Ponty on the Nature of Science

The question which modern philosophy asks in relation
to science is not intended either to contest its right to exist or
to close off any particular avenue to its inquiries. Rather, the
question is whether science does, or ever could, present us with
a picture of the world which is complete, self-sufficient and
somehow closed in upon itself, such that there could no longer
be any meaningful questions outside this picture. It is not a
matter of denying or limiting the extent of scientific knowledge,
but rather of establishing whether it is entitled to deny or
rule out as illusory all forms of inquiry that do not start out
from measurements and comparisons and, by connecting particular
causes with particular consequences, end up with laws
such as those of classical physics. This question is asked not
out of hostility to science. Far from it: in fact, it is science
itself – particularly in its most recent developments – which
forces us to ask this question and which encourages us to
answer in the negative.

– Merleau Ponty, The World of Perception and the World of Science

 

We merely have to realize that our ‘adoption’ of scientific theories can only be tentative; that they always are and will remain guesses or conjectures or hypotheses. They are put forward, of course, in the hope of hitting upon the truth, even though they miss it more often than not. They may be true or false. They may be tested by observation (it is the main task of science to make these tests more and more severe), and rejected if they do not pass… Indeed, we can do no more with a proposed law than test it: it is no use pretending that we have established universal theories, or justified them, or made them probably, by observation. We just have not done so, and cannot do so. We cannot give any positive reasons for them. They remain guesses or conjectures- though well tested ones.”

– Karl Popper, Realism and the Aim of Science

Solving the Liars Paradox

This just popped into my head randomly a few days ago at work. My solution is basically that of Tarski’s but I’ll explain in laymans terms. The liars paradox is not just neither true or false but that it’s a valueless statement. 

First lets define 2 different types of statements. A) Suppositional statements and B) Empirical statements. The former is essentialy a priori and the latter a posteriori, however, suppositional statements refer to concepts that exist outside of reason or observation (yet beneath it) and are always “true.” 

Empirical statements are what we test to against our suppositions for its vadility. For example, the statement “all unicorns have 4 legs” as an empirical statement, is actually valueless because unicorns do not exist either by rational logic or by observation, therefore no test can be made against something that doesn’t exist. 

However if we were to make a supposition that “a unicorn has 4 legs” then the empirical statement “all unicorns have 4 legs” becomes a true statement. For empirical statements to to work, a suppositional, rational, or observational truth must precede it. 

However notice that in the example, suppositional statements still refer to things of observation (e.g., legs). Suppositions are a lesser truth than observational and rational truth and essentially works inside its paradigm.

If a thing does not exist in-itself or is logically false then it cannot be used as an attribute in a supposition statement. Therefore the truth or fasifity of something cannot be used as an attribute. 

Grammatically it’s redundant because whatever being said is true and secondly, truthness or falseness does not exist in-itself. Rather it’s what we say when something is in accordance to our reality, logic, or suppositions. Therefore the supposition that “all statements are true” cannot exist and the empirical to statement that “this statement is false” is also non-existent or valueless as well since there is no supposition to test it against. 

One minor difference from Tarski is that it resolves the infinite hierarchy problem since suppositional language is within a greater paradigm of truth language so therefore there is no problem (or better put, need) of defining truth for the whole hierarchy.

Hayek’s Ricardo Effect Hypothesis

I have not read a page of Hayek’s Interest, Prices, and Production in like over a month. However I still have notes I took so I could use for a blog post. In the books first chapter, Hayek construes a hypothesis of business cycles where:

Under certain conditions, contrary to a widely held opinion, an increase in the demand for consumers’ goods will tend to decrease rather than to increase the demand for investment goods… [and that] these conditions will regularly arise as a consequence of the conditions prevailing at the beginning of a recovery from a depression

– Interest, Prices, and Production pg. 3 (emphasis mine)

Hayek’s hypothesis was well within the framework of the Austrian Business Cycle Theory. The cycle starts when a boom (caused by artificially lowered price of credit) causes more investment in capital and along with that boom and greater capital investment, the economy sees a further expansion in credit and rise in prices.

However he was particularly interested on the rate of profit and not the interest rate as most Austrian business cycle theorists are. He believed it was the increase in rate of profit that causes demand for consumer goods to lower the demand-schedule for investment and consequently increase unemployment.

Hayek explains how this “Ricardo Effect” can happen by starting with the following assumptions

  1. The economy is not at full employment
  2. Rigidity in wages (i.e., sticky wages) and labor mobility
  3. Existing capital is being used for a fairly specific purpose
  4. Constant money rate of interest
  5. Fixed nominal wage
  6. More credit means higher prices

The latter two assumptions entail that higher prices will result in decreasing real wages. Because of this, we’ll see why the boom is self-reversing as more investment in labor will lead to less investment in capital.

The name of the hypothesis comes from David Ricardo’s chapter On Machinery where he states that when price of labor goes up, more capital is used instead and vice versa

Ever since I first turned my attention to questions of political economy, I have been of opinion, that such an application of machinery to any branch of production, as should have the effect of saving labour, was a general good, accompanied only with that portion of inconvenience which in most cases attends the removal of capital and labour from one employment to another.

– On the Principles of Political Economy and Taxation pg. 34; 31.2

The profit earned on the turnover of labor equals to the difference wages minus the price of the marginal product of labor.

πt = PMPL − W

Where πis turnover profits; PMPL is the price of the marginal product of labor; and W is wages

As the price of a product increases; turnover profit does as well regardless of the length of the turnover and time rate of profit increases for labor in shorter periods of turnover than longer ones.

The result is that:

A rise in the price of the product… will lead to the use of relatively less machinery and other capital and of relatively more direct labour in the production of any given quantity of output.

– Ibid pg. 10

Hayek uses the following table demonstrate this:

2 years of invested labor

1 year

6 months

3 months

1 month

Initial percent amount of profit on each turnover

12%

6%

3%

1.5%

.5%

Corresponding an annual return rate

6%

6%

6%

6%

6%

Rate of return after a 2% increase in the price of the product

14%

8%

5%

3.5%

2.5%

Corresponding annual rate of profit of

7%

8%

10%

14%

30%

The equilibrium annual profit rate (ignoring compounding effects) on labor invested for different periods is 6 percent. It is then assumed that the price of the product increases by 2 percent.

In the case shown by the table the per annum rate of profit is raised, by a rise in the price of the product of only 2 per cent, from 6 to 7 per cent on the two years’ investment and from 6 to 30 per cent on the one month’s investment. This will, of course, create a tendency to use proportionately more of the latter kind and less of the former kind of labour, i.e., more labour in the last stages of the process and less in the form of machinery or for other work of preparatory character, till by a fall of the marginal product of the former and a rise of the marginal product of the latter kind of labour the time rates of profit earned on capital  invested in each become once more the same. Or in other words: a rise in the price of the product (or a fall in real wages) will lead to the use of relatively less machinery and other capital and of relatively more direct labour in the production of any given quantity of output.

– Ibid pg. 9-10

A change in the product’s price relative to the money wage rate is a change in the “real wage.” The analysis is a roundabout way of referring to the effects of an increase in the value of the marginal product relative to the wage rate in some areas of labor employment and a decrease in others.

By “real wages” Hayek did not mean the nominal wage rate divided by the cost of living. Instead he’s referring to the nominal wage rate over the price of specific product the worker is producing; not goods he is consuming.

Real wages may fluctuate irrespective of their measurement in terms of a unit of general purchasing power. Statisticians have often been confused about what constitutes the relevant real wage in economic analysis of the business cycle. The wage as measured in units of industrial output is what is important for labor demand, whereas the wage as measured in units of consumables is relevant to labor supply

– Economics as a Coordination Problem: The Contributions of Friedrich A. Hayek; para. 5-19

Illustrating It Graphically

Hayek uses the framework of Oscar Lange’s graph of his Role of Interest in Production theory.

Capture
Figure 1

Along the x-axis (O-P abscissa) is the total quantity of labor used in a particular process of production and is assumed to be able to be distributed in a various ways between investment for one year or two years.

The measurement of the amount of labor invested in one year moves from right to left so that the rest of the abscissa measures the amount for two years. Any point on the abscissa corresponds to a given distribution of the fixed total of labor between the two types of investments.

There are two curves that show the marginal productivity of invested labor and is measured along the y-axis (O-Y ordinate)

The marginal product of invested labor for two years is shown as a downward sloping curve moving from left to right. The marginal product of invested labor for two years is shown as a downward sloping curve moving from left to right.

Similarly, the marginal product of invested labor for one years is shown as a downward sloping curve moving from right to left.

Hayek assumes that the 2 year invested labor is complementary to 1 year invested labor. The distribution of labor between the two types of investments is set by the price of real wages.

Real wages are at W as shown in figure 1.

The profits for 1 year investment is represented by the ordinate RS and profits for 2 year investments are represented as the ordinate RT.

In order to reach equilibrium, profits from two year investments needs to be twice the amount of that from 1 year investments or as an equation:

E = RT = 2RS

Where is equilibrium.

Capture2
Figure 2

Suppose then that real wages are lowered to W’ on figure 2, this will make profits on two year investments (R’T’) so that it is now twice the amount of profits for one year (R’S’). In consequence, this causes a leftward shift of the M curve (quantity of employed labor) to M’.

The fall in real wages also results in the proportional amount of labor for one year investment (abscissa PM) to increase to PM’ and correspondingly decrease the proportional amount of labor for two year investment to (OM) to OM’. The result can be more clearly seen in Figure 3

capture3
Figure 3