I was hoping that Neo-classical would explain it. He has read so many books.
Again, interest rates are “high” if they are elevated above the natural rate, and they are “low” when they are suppressed below the natural rate. A 3% rate of interest may be “too high,” and 25% interest rate may be “too low.”
No one ever responds to this point…
Neoclassical, I’ll again have to repost a reasoning you didn’t refute. How does RE counter this:
But it doesn’t make sense for people to follow rule (b)* for 2 reasons:
- They might have a lower investment horizon than the expected duration of the low interest
- They might be able to lock in the low interest rates using options for all investments regardless of interest expectations
- Rule (b) was you saying rational entrepreneurs would refrain from investment which would be profitable only with the lower interest rates provided by monetary policy.
f interest rates are market phenomena, and human actors can never accurately predict market phenomena, how can interest rates ever be set to a “natural” price?
They can’t.
How about the fact that the vast majority of individuals know nothing about economics/trade cycle theory? Let’s ignore everything else for a moment.
The very function of manually setting a market rate of interest is to fool entrepreneurs(IE alter their behavior). The whole premise is to alter market behavior away from what it would have otherwise done if left alone. If businessmen immediately accounted for the incorrect alteration of interest and adjusted their activities it would undermine the whole point that the central bank is trying to accomplish. The Central bank wants people to continue in ignorance of any natural rate of interest.
Now eventually business’s and banks do account for the incorrect rate of interest and peg a premium on their credit in anticipation of inflation. When this occurs the market begins to correct itself. IE, the market in general becomes aware that the time structure of production now may be in direct conflict with consumers interests. if the central bank wants to keep manipulating the market in their favor and avoid the correction they must take even more drastic measures to keep the market operating in the way that they want. That means making credit even more available, and pushing interest rates down even farther. If the pattern continues you end up with more business cycles or a crack-up boom(Hyper-inflation). The latter is far less common.
Furthermore even if entrepreneurs did not tap into the cheap credit made available by low interest rates, they do so at the risk of losing their competitive edge during the boom phase. In order to remain competitive most firms must participate by leveraging themselves on the newly issued money which has been made available.
Back to your point however, humans can no more predict the market rate of interest then it can predict the “market” rate of apples. Interest is really the price of time, and is decided subjectively across countless individuals via the market process. The price is done by a method of discovery. The market rate of interest is discovered, not set.
Eugene von Bohm-Bawerk will expand on the knowledge of interest. It’s not just simply a market phenomena, it’s also arguably a time phenomena that even individuals, in the absence of markets, experience. For example Robinson Crusoe experiences it on his island when he saves his berries so that he can spend a day building a catch-net.
You can read up on the PTPT as a baseline, and Austrian’s then build from that.
Natural in this context means with no govt involvement, but rather decided by the voluntary interactions of people seeking to maximize their profits.
In other words, to put it simply, when the Fed doesnt exist, and someone applies for a loan, and he winds up signing a paper that he will pay 5% interest [or whatever number], then 5% is, by definition, the natural rate at that moment for that transaction.
Esuric, how can we discuss “rational expectations” and than say “people don’t know about lowered interest”?
If people know about lowered interest, as they should according to rational expectations, the two points I stated logically proof that the structure of production is affected and thus can not be ignored.
Unless neoclassical has an answer of course.
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Can someone prove to me that businesspeople pay attentiont to short-term interest rates rather than long-term interest rates?
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Do workers in consumption goods enjoy a “boom” during a depression?
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Why would entrepreneurs make stupid investments? It’s so crazy! Even having more credit doesn’t mean they need to run and make long-term investments.
That’s because it’s true. How does one counter this?
Because they didn’t know any better/couldn’t know any better. 
Isn’t it stupid to spend money on being unprofitable? Yet there are still firms which are unprofitable and go under.
Neoclassical, it’s rational to go along with the fake boom, as you know all that fake money has to end up somewhere. Also, consumer good employees simply take less of a hit if interest rise again to natural levels, but of course investments in that area also slow down.
It’s not necessary. Both short and long term interest rates are set by the same factors. The only variable difference between the two is time.
It would be beneficial for you to spend some time in researching on what Austrian’s consider interest to be and how it relates to the accounting profit of various stages of production in the economy. It doesn’t necessarily have anything directly to do with loans and lending.
As was stated in my other threads, during the boom all stages of production expand laterally, that includes stages closest to consumption. IE workers in consumption goods enjoy a boom most, during the boom, not during the bust.
It’s not about stupidity, it’s about being told wrong information regarding market materials. The investments at the time may have very well been sound. Halfway through the projects completion however new calculations and business analytics show, based on a new price structure of raw materials, that their original forecast of cost was incorrect.
Everyone is drawing from the same resource pool at once, your going to have a general rise in prices regarding objects in that resource pool.
So again it’s not a matter of stupidity.
I heard Peter Schiff saying that long term interest rates are set by people’s expectations of inflation. But I guess they think inflation is not that much of an issue short term.
Smiling Dave, almost every serious mainstream economist believes that money is neutral in the long-term (due to rational expectations).
Some, like me, have a suspicion that it is neutral in the short-term, but others disagree (monetarists, New-Keynesians, etc.).
Expectations regarding inflation (or deflation) affect the premium that is set above or below the originary rate of interest (natural rate). But only time preference sets the natural/originary rate.
do you have arguments for dismissing cantillon effects?
"Smiling Dave, almost every serious mainstream economist believes that money is neutral in the long-term (due to rational expectations).
Some, like me, have a suspicion that it is neutral in the short-term, but others disagree (monetarists, New-Keynesians, etc.)."
Milton Friedman’s explanation of the inflation tax and transfer of wealth associated with this tax was explained how exactly? By the neutrality of money? You gotta be kidding me. Do you need to watch the “Free To Choose” episode where he explicitly explains how the first beneficiaries gain at the expense of the last?
So even Friedman and most subsequent economists recognize that money in the short term is not neutral. That they disregard this short term effect in monetary theorizing is the Austrians’s greatest criticism of monetarism.
DD5, I explicitly stated that monetarists believe money is non-neutral in the short-term.
Upon re-reading, you make even less sense to me now.
Your first quoted sentence says that Friedman acknowledges that “money in the short term is not neutral,” but in the second sentence you say “they disregard this.” How can both be true?
Austrian’s do not regard money as neutral. The very concept makes no coherent sense whatsoever.