Mises Doesn't Think Interest Rates Affect Savings Rate?

Economics Economics Questions
1

I’m looking over Bob Murphy’s Study Guide To Human Action, and in Chapter XIX: Part 3 (“The Height Of Interest Rates”), he summarizes Mises as saying “It is incorrect to say that a higher interest rate draws forth more savings and vice versa. Rather, the discount people place on future goods determines both the amount of saving and the height of interest rates.”

But I just can’t help but think that if the market rate of interest goes up, an individual might respond to this by saving more, in order to invest in investments with higher returns. Can someone help explain this in Dummie terms for me?

2

I would interpret it as direct causality. It’s not the high rate of interest that causes higher savings, rather the utility of future goods versus present goods (a utility which will be influenced, of course, by the rate of interest).

3

Hmm, but this seems to be saying that the utility of future goods versus present goods determines the interest rate, while at the same time the interest rate influences the utility people place on future goods versus present goods. Which is it?

What am I missing, here?

4

I can’t comment on the validity of Mises’s time preference theory of interest (a theory critiqued both by Reisman and Hülsmann, for instance), and I can see where the contradiction might be (although, in this case the contradiction is really created by my interpretation). What pages is Murphy referring to?

5

I think perhaps I understand where I went wrong…I might be muddling personal rates with market-wide rates.

The market-wide time preference rate determines the market-wide rate of interest, which influences my personal time preference rate, which influences my personal savings rate. Therefore, rises in market rates of interest set off a chain reaction resulting in a rise in my personal savings rate, but one does not directly cause the other.

Have I finally gotten it right? Lol.

Murphy is referring to pages 532-534 of Human Action, by the way.

6

This is the relevant passage from Human Action:

People do not save and accumulate capital because there is interest. Interest is neither the impetus to saving nor the reward or the compensation granted for abstaining from immediate consumption. It is the ratio in the mutual valuation of present goods as against future goods.

The loan market does not determine the rate of interest. It adjusts the rate of interest on loans to the rate of originary interest as manifested in the discount of future goods.

The following is how I understand this difficult topic, based on my reading of the chapters discussing interest.

When Mises says simply, “the rate of interest”, he’s talking about “originary interest”, which is something more fundamental and pervasive for the economy than what he calls the “the gross market rate of interest on loans”, which most people think of when they hear the term “interest rate”.

Originary interest, as Mises wrote earlier in that section, manifests itself as the discount of the price of future consumers’ goods [which include present factors of production which later “ripen” to become consumers’ goods] as against present consumers’ goods. By virtue of their remoteness in time, future goods always have a discount in relation to present goods, and this discount varies from person to person. If in general, future goods suffer a severe discount with people in an economy (which is the exact same thing as saying there is a high originary interest), then people will generally only be willing to give up a certain amount of present consumption if the later consumption they get in exchange is much greater. That is to say, they are less likely to save. If, on the other hand, in general, future goods only suffer a low discount with people in an economy (which is the exact same thing as saying there is a low originary interest), then people will generally be willing to give up a certain amount of present consumption even if the later consumption they get in exchange is only moderately greater. As Mises said, high originary interest is not an “impetus to save”. Far from it; a society with high originary interest is less likely to save, not more. Neither is originary interest the reward for saving: how can something that is defined as a “ratio” and which manifests as a “discount” be a “reward”?

Now on to the consumers’ loan market (as Rothbard explains here the producers’ loans are not an independent factor in the “time market”), which is a market of present money exchanged against future money. Market rates of interest on loans tend to move toward the originary interest rate (which, again, is the ratio of present consumers’ good prices to future consumers’ good prices [which include present factors of production]) because the present money involved is intended for present (or nearly present) consumption and the future money involved is intended for future consumption, which is why Mises said that the loan market, “adjusts the rate of interest on loans to the rate of originary interest as manifested in the discount of future goods.”

7

If you’re tired of the pitiful interest rate on your savings account at the bank, you may want to look into U.S. savings bonds for an equally safe place to keep some of your savings. With most bank accounts, the safety of your money comes from being insured by the Federal Deposit Insurance Corporation, or FDIC. This provides insurance on up to $100,000 per depositor. Unfortunately, while your money may be safe, there is a good chance the interest rate on the account is quite low.

With U.S. savings bonds, your money is also safe, but it isn’t through FDIC insurance. Savings bonds are backed by the full faith and credit of the United States government. For individuals who are seeking safety of their principal, they can rest easy knowing that as long as the government is around, they are obligated to repay your principal and interest.

8

If I’m understanding the problem correctly, it doesn’t really have anything to do with the interest rate per se, but how the Austrians view supply and demand in general. In the typical Neoclassical framework, one learns that the price is the independant variable while the quantity demanded/supplied is the dependant variable. This means that price determines quantity demanded. So if the price of a good increases, then an individual’s demand function will make the individual demand less of the good.

This interpretation however, is technically not correct, and it is a perfect example of methological difference in Austrian versus Neoclassical price formation, i.e, the value scale approach versus the income/substitution indifference basket approach. With regards to the Neoclassical approach, Austrians criticize it due to the problem of circularity: If the price of a good X determines the demand/supply schedules, and those demand/supply schedules determine the price of good X, then an apparent problem arises. How is the price of good X actually determined? How can the demand/supply schedules determine the formation of a price when they are “dependent” on the price it is trying to explain? This is an example of “mutual determination”, a mathematical slight of hand that has evaded economics from developing accurate theory of price formation.

Instead, Austrian economics says that prices are determined by demand schedules (which is composed of various rankings of additional units of a good and forgone units of money) and supply (which is composed of various rankings of additional units of money and forgone units of a good). So if an entrepreneur “posts” a higher price on a good (say $15) it is not the price that determines the quantity demanded, but the individuals ranking of an additional unit of the good versus the forgone $15. This determines what the individual will demand and what the final equilibrium price will be. As Rothbard puts it “Keynesians might object that all demand and supply curves are “mutually determining” in their relation to price. But this facile assertion is not correct. Demand curves are determined by utility scales, and supply curves by speculation and the stock produced by given labor and land factors, which is ultimately governed by time preferences.” (MES 786)

The analysis equally applys to the analysis of the formation of the interest rate, except that time preference must be added (and individuals instead balance present amounts of money added/forgone with future amounts of money forgone/added). Or put in Rothbard’s words "Many economists have made the great mistake of believing that the interest rate determines the time-preference schedule and rate of savings, rather than vice versa. This is completely invalid. The interest rates discussed here are simply hypothetical schedules, and they indicate and reveal the time-preference schedules of each individual. In the aggregate, as we shall see presently, the interaction of the time preferences and hence the supply demand schedules of individuals on the time market determine the pure rate of interest on the market. They do so in the same way that individual valuations determine aggregate supply and demand schedules for goods, which in turn determine market prices. And once again, it is utilities and utilities alone, here in the form of time preferences, that determine the market result; the explanation does not lie in some sort of “mutually determining process” of preferences and market consequences." (MES 382)

9

Time preference, and time preference only, determines the natural rate of interest, also known as originary interest. If, for example, the market or money rate of interest rises above this natural rate, due to alterations in monetary factors, than savings will rise more than it otherwise would have. This avoids circularity, where interest rates determine savings rates, and savings rates determines interest rates.

10

It is correct to say that the savings rate may change when the interest rate rises, but what Mises is doing is making the distinction between a “change in demand” and “a change in quantity demanded”. A change in the interest rate can only bring about a change in quantity demanded, the actual demand schedule of the individual stays the same.

Or to put it another way it’s the distinction between a shift in the demand schedule itself, and a change in the point along the demand schedule where the market clears.

11

“The full faith and credit of the US govt”? Why does this make me smile? The German Savings Bonds in 1923 were backed by full faith and credit of the Weimer Republic. The Zimbabwe Savings Bonds are, to this day, backed by the full faith and credit of their gov’t and everyone is being paid principal and interest scrupulously. But the guy who bought those bonds with money that had purchasing power was repaid with money that has no purchasing power, because of high inflation.

And that is the fear here also. QE1, 2, 3… are, by definition, creators of inflation, which we are experiencing already.

12

"If you’re tired of the pitiful interest rate on your savings account at the bank, you may want to look into U.S. savings bonds for an equally safe place to keep some of your savings. With most bank accounts, the safety of your money comes from being insured by the Federal Deposit Insurance Corporation, or FDIC. This provides insurance on up to $100,000 per depositor. Unfortunately, while your money may be safe, there is a good chance the interest rate on the account is quite low.

With U.S. savings bonds, your money is also safe, but it isn’t through FDIC insurance. Savings bonds are backed by the full faith and credit of the United States government. For individuals who are seeking safety of their principal, they can rest easy knowing that as long as the government is around, they are obligated to repay your principal and interest."

I LOL’d! Is that you Turbo Timmy?

13

This is the first-ever Human Action Study Guide, and congratulations to Robert Murphy for being the only person in 60 years to complete this much-needed task that has been attempted many times before.