struggling to learn austrian interest theory

Economics Economics Questions
1

i just been reading:
A defense of the traditional austrian theory of interest
by paul cwik

in the essay Cwik qoutes Hulsmann who had written:

When I lend 100 ounces of gold now to receive 90 ounces in one year, I thereby
demonstrate my preference for having these 90 ounces from my debtor sooner rather
than later. It is true that it seems to be pointless to lend money at –10 percent. Why
indeed should a man find it valuable at all to give up 100 ounces of gold now, only to
receive a mere 90 ounces back at some point in the future? Why should he not just
keep the money rather than make such a contract? These are of course very good
questions, but Mises’s time preference theory does not answer them.

cwik says:
The example of an exchange of 100 present dollars for 90 future dollars is odd
because of Hülsmann’s acknowledgment that time-preference is a universal condition of
human action. The conditions that would make 90 future dollars preferable to 100
present dollars must be such that a state of change must exist between these two time
periods. Thus, this example violates the ceteris paribus assumption. It commits the same
error that is explained above in the section on “Knowing One’s Future Goods.”
Hülsmann fails to explain how such examples are not generalizable and thus fails
to make his argument. This argument merits more attention and should be explored in
further research, but as it stands now, it is not a valid criticism against the traditional
Austrian theory.

The sentence which catches my eye here is:
The conditions that would make 90 future dollars preferable to 100
present dollars must be such that a state of change must exist between these two times.

it would seem that cwik has in mind a state of affairs change such that deflation has occured so in a year 90$ might have the same purchasing power as 110$ does ‘now’ and that such a change would justify the apparent paradox.

thoughts?

But then, if we can think of other scenarios, that dont involve such state changes, would that give hulsmann more power?

im thinking if for example, say John has 100$.
John is at a hangout when the neighborhood bully can be seen approaching from a distance, with no means of escape John is afraid that , as in times past, the Bully will rifle through his possessions and make off with his wealth. wishing to divest himself of the funds quickly before the bully returns john strikes a deal with an honest fellow who is off the bullys radar. here, hold these 100$ for me, and i’ll let you keep 10 when you give me 90$ back. just hold it for 10minutes for me. and so the bully comes, finds no money, and John is restored to his remaining 90$. in accounting terms he has suffered a 10$ loss, or negative interest. in terms of ‘gain’ however the by choosing not to risk losing 100$ which would mean having 0$ has been avoided so he is 90$ the gainer. in terms of interest John has used the less avlued means (100$ that would evaporate to nothing) to achieve his higher valued end (90$ that can be relied on) and such reaps the interes that is his subjective value spread between the two things exchanged. in this short interval time that would contain the event the purchasing power of the us dollar remained the same.

did this make any sense? im trying to get my head around notions of profit and interest in as technical a form as i can manage. and i mafraid to say time preference theory might have the better of me…

anyone willing to tutor me about the cutting edge of interest theory austrian style? what of the argument between Rothbard and Reisman on profits /interest rate in an economy declining to zero, or remaining positive.

2

The example you mentioned is also a case were ceteris are imparibus, hence making Cwik’s point for him again.

-Jon

3

Yeah, why would someone give up current consumption for something less valuable in the future?

In the first example I could buy 10 chickens today or loan the money out and buy 9 chickens in a year if nothing changed. Not only does this go against time preference of a good today is more valuable than a good in the future but doesn’t make any sense considering the fact that there is negative compensation for losing control over their assets over the time of the ‘loan’.

Who wouldn’t take a deal from someone that pays you to have complete control over their money for a year.

I’m pretty sure that Mises’s time preference theory also doesn’t specifically deal with an equally realistic example of catching a leprecaun and getting his pot of gold but that doesn’t invalidate his theory.

4

thanks for the suggestions im just trying to get a grip on this, my gut tells me Hulsmann means and ends theory can explain more phenomenon…

thought its obvious you disagree, so hopefully i can learn from discussing with you. i havent made up my mind all that strongly about it either way.

lets say i have 100$ today, in crips $notes, but i have a bizarre phobia of notes, or else i am allergic to the chemicals in their manufacture, then i would benefit from a negative rate of accounting interest, because by subjective value theory, and my end of being free from fear or being free from allergic reaction would give me a benefit over maintaing the means to that that end (the notes whcih can be disposed of) even when added to the other purchase opportunities by holding the dollars, what of this?

and more generally, which austrian scholars should i even consult to get a thorough grounding on this. I remember clicking on a link recently on mises.org on a Rob Murphy article and it had a link to Study Guide for Interest Theory, and i pressed the link and it was dead. and i was dissppointed.

5

I guess you could argue that point in the absence of a healthy market for loanable funds where you have to pay somebody to take them off your hands instead of profiting from it for whatever reason.

Get pretty much the same effect today by purchasing a CD with negative inflation adjusted interest rates.

Whole bunch of stuff to chose from on mises.org.

6

Do you have a specific question about interest rate theory? You might explore the concept of time preference, a bit. (shameless self-promotion)

Even if there were sound money and no threat of inflation, an interest rate would still manifest itself through the discounting of future with regards to present. Time preference can not be arbitraged away. Although the degree to which time preference manifests itself is individually unique, some degree of preference for present consumption over future consumption is axiomatic…

At its root, interest is fundamentally the price of present goods in terms of future goods.

I would also recommend Hulsmann’s Further considerations in the Theory of Interest (mp3). It’s a bit heavy, and you might need to listen to it more than once.

7

thanks AnoCow, ive certainly picked around the edge of those 300 links, its all a bit slapdash though. oh well, if theres no structured jump off point, i’ll perhpas need to order my own!

8

Yeah, just a google search.

If you really want to learn just download the pdf of Man, Economy and State and read that section. Ch. 6 I would guess.

9

david, i understand that time preference does insist that moral agents such as us will only ever act (intentionally), when so acting would bring about our sought after ends by virtue of the means that we employ, Sooner Than, than it would take to achieve our ends if we did not employ our means and delayed acting. (thus internally our subjective interest rate would always be in a positive ratio, but for outsiders it may appear disengeniously as if we held negative interest rate or negative time preference?)

doesnt hulsmanns point apparently still stand?, and contradicts Cwik’s instinct, that we might subjectively value an end that to a 3rd party observer they would guess we are crazy and exhibiting negative interest rate, because they are thinking in cardinal or objective value terms, and fail to see that in some circumstances agreeing to recieve back a fraction of a quantity of a good, whose larger part we own now, can be commensurate with time-preference and interest theory, because of the subjective value spread between what we expect to profit subjectively in achieving our end despite the subjective cost of disposing/using/consuming our means?

10

I’d have to brush up on it, preferably to read the Hulsmann passage that cwik cited. I’m rather surprised that Hulsmann would put such an idea out there, given what I’ve read/heard of his on the topic. I think the examples mentioned in this thread are not only cases of ceteris imparibus, they are not truly cases where it is appropriate to discuss in terms of interest (e.g., the bully who steals your money.) In these circumstances, it is far more appropriate to view the transaction as payment for services rendered or payment for safekeeping, etc.

11

Jon, it would be an incredible assistance you would provide in helping identify how the examples are ceteris imparibus?

perhaps i am making a mistake (you surely think i am, i merely am terribly unsure!) but i was thinking ceteris imparibus would be if between time t1 and time t2 some subtle variable which should have been held constant has been allowed to variable hence consitituing the fallacy. yet, at first glance, it seems the xamples cited, do not have such a state change, the considerations which lead to the eccentric effects are to be found in the ‘calculating’ step of the subjective agent under question, who judges his means and ends all at t1, and decides on a course of action so that by the time t2 comes around, he expects to have improved his circumstance, (to have profited interest)…

12

http://mises.org/journals/jls/2_2/2_2_4.pdf in Walter Blocks

THE NEGATIVE INTEREST RATE: TOWARD A TAXONOMIC CRITIQUE

am i interpreting correctly that Walter Block is agreeing with Hulsmann, and my own burgeoning thoughts, that what appear to be “negative interest rates” to outside 3rd party observers, can not be mapped on to internal negative time preference in the mind of the agent expressing the rate, who must necessarily have a positive time preferences, and is betrayed in this, by his acting (whic hreveals a propensity to prefer disposing of means to achieving ends) in the way hulsmann write, or perhaps as block may say ( i dread trying to put words in his mouth) the agent prefers present goods to future goods, but if it appears to an outsider that eh doesnt, that is good reason for believing that to the choosing agent the goods are not homogenous.?

13

I just re-read the quoted passage. It seems to me that what Hulsmann is saying is that the Misesian treatment of time-preferential interest theory is invalidated by such a circumstance (lending 100 today in return for 90 in a year). Hulsmann questions the apparent paradox:

“Why should he not just keep the money rather than make such a contract? these are very good questions, but Mises’ time preference theory does not answer them.”

And concludes that since Misesian theory cannot solve this paradox, that the theory is incomplete or invalid. Cwik says, “Not so fast, Jorg.” Unless Hulsmann can generalize this scenario, it is not a valid criticism of Austrian theory. Mises’ time preference theory does not answer questions that it can not answer. Positive time preference is axiomatic (this is an argument I belive Hulsmann has put forth elsewhere). Unless Hulsmann can demonstrate that positive time preference is not axiomatic, we have to assume that the information given in the problem is not sufficient to solve it, and that one (or more) of our assumptions have changed.

You ask, “it would seem that cwik has in mind a state of affairs change such that deflation has occured so in a year 90$ might have the same purchasing power as 110$ does ‘now’ and that such a change would justify the apparent paradox.”

This change (a deflation on the order of ~20%) could not justify the apparent paradox, because if the lender had simply held his own money (instead of lending it) his initial 100 oz at T1 would have relative purchasing power of 122 T2 (relative to T1).

14

What I mean is, I don’t even see how interest rates figure into this. I agree with david when he says this is more like payment for a service than anything else. Look at it this way, if paying off the bully would only render satisfaction in the future as opposed to now, would you value that more than immediate satisfaction of ridding of him? Again, a present benefit is preferred to a future one.

-Jon

15

thanks for your response dave, (thanks for taking an interest ;-))

I think hulsmann’s critique of mises time preference theory, is that given that it is logically possible for an agent to rationally accept a negative rate of “accounting” interest or ‘money’ interest ((not value interest), that time preference theory as mises has it alone, is not sufficient to explain observed rates of money interest in the world.

i dont yet understand why an exception needs to be ‘generalizable’, surely an examplary exception is an exception regardless of whether other excpeiton that share a general form can be found ?

doesnt hulsmann agree with time preference theory?, saying in how agents order the values of their means and their ends, betrays their time preference, to have their ends met sooner. Then he can go one to use the subjective value spread between the settled on end and its means (and the foregone ends) to arrive at a subjective interest theory, in a way that mises cant do, as mises is writing about time preference in ‘googs’, whereas hulsmann is more accurate in talking only about time preference of means and ends. which means mises is over stating what can be said by ‘time preference’ when applied merely to goods. without introducing means and ends, we cant go as far as we would?

argh. my head hurts.

p.s. my deflation mention now makes me feel like an idiot

16

i think it figures in because ‘profit’ or ‘benefit’ as you write is synonymous with ‘orginary interest’ . a value spread between means and ends. that can involve a productive period through time, but can equally be an instantaneous phenomenon ie. when a trade of titles to a good occurs. i think Hulsmann makes precisely this point.

Qoutes -

Smith seeks to attain his end (tomato) by means of his apple, and Jones uses his
tomato as a means to acquire the apple. Why is it that for Jones the tomato is less valuable
than the apple, and why is it that for Smith the apple is less valuable then the
tomato? From the point of view of value imputation theory, this question cannot be

answered. Advocates of this theory would have to hold that for Jones the tomato has

the same value as the apple, because the value of the apple would be fully imputed to
the tomato; and mutatis mutandis the same consideration would apply to the case of
Smith. Thus, the exchange presents us with a paradox. Why would Smith and Jones
engage in their barter if they do not value the price they pay less than the good they
receive?

Our theory of originary interest delivers the common-sense answer to this question.
Smith and Jones do not impute the value of their ends onto their means. Smith
values his apple (means) less than Jones’s tomato (end), and therefore he desires to
make the exchange. Thus we see that market exchanges are mutually beneficial
because of originary interest. The services given up in an exchange, and the exchange
itself, are but means to enjoy services that one values more highly than those one surrenders.
Again our theory of originary interest leads to a significantly different result
than the time preference theory. The latter confines the phenomenon of an agio
between means and ends to those cases in which the use of means and the attainment
of ends do not coincide in time. But there is an agio between means and ends also in
spot market exchanges—certainly not an ephemeral phenomenon. It follows that, even
if time preference in some way determined money interest, it would not be the only
determining factor, but merely one out of two causes operating to the same effect.

-damn that woute was way long

17

What is Hulsmann’s theory exactly? Try summarize it in your own words. I’ve not read him, and the quotes don’t make much sense divorced from any context.

-Jon

18

my interpretation of hulsmann ,is that he is strict about subjective valuationof value of ‘goods’, and when considerations about inter-temporal exchange of such goods is in question, one must focus ones study on the Means and the Ends of the agent. If there is a time preference, it is just to orient, the ends as superior in subjective value to their means, by the definition of having asigned them with labels ‘means and ends’ , and also perhaps that achievement of a given end sooner is better than later ceteris parabus.

interest/profit is the subjective value one reaps, in the difference between the end that you get minus the forgeone means and other competing less attractive ends.

19

So he is trying then to subsume the phenomenon of interest under the general theory of valuation?

-Jon

20

i guess so. but obviously Cwik disagrees with him in the details, unless theres been a misunderstanding.

oh well, back to the books…