Clayton, is the use of the word “round” the problem here, or something else? I am not sure if Hayek uses the word “round” or not (does he use stages instead?), but what he tells is pretty much the same, I guess. He addresses Fosters and Catchings who say savings would cause production costs to be too high to be compensated by the little consumption spending made on the products manufactured. Hayek says savings would be used to produce capital goods that would be capable of producing consumer goods over a longer period of time (what he calls a lengthening in the production process is nothing but a longer period of time to break-even) to help compensate for the investment made. Am I getting Hayek wrong on this?
Regarding the nature of profits, I am talking about this quote from Mises (see chapter 15, sub-sections 8 and 9 in “Human Action”): “There is nothing “normal” in profits and there can never be an “equilibrium” with regard to them. Profit and loss are, on the contrary, always a phenomenon of a deviation from “normalcy,” of changes unforeseen by the majority, and of a “disequilibrium.” They have no place in an imaginary world of normalcy and equilibrium.”
My question has to do with how well entrepreneurs anticipate the “disequilibrium”. If profits are about disequilibrium, and if increased savings aggravates the disequilibrium (thus incentivizing entrepreneurs to correct the disequilibrium), then the chance to make profits would cause an increase in the interest rates, no?
His disagreement has nothing to do with what you claim. Hulsmann would certainly not claim that the causation is from market rate of interest to investments.
Well, we have to have conceptual clarity regarding what we’re talking about - the Austrian model is the Evenly Rotating Economy. The idea of “rounds” suggests that there’s some kind of collective or aggregated action taking place. In the ERE, there is no collective or aggregated action, there is just an artificially constructed “ceteris paribus” situation, so it doesn’t really make sense to speak of “rounds” to me. Perhaps there is an Austrian that uses this terminology but I would be curious to see his definitions.
I’m pretty sure this is incorrect, can you provide the quote? Break-even has to do with a specific firm whereas a lengthening of the production process has to do with all firms. Specifically, a lengthening of the time-structure of production is evidenced by the emergence of entirely new types of firms or services from existing firms that serve ever more roundabout production processes.
He’s just saying that you can’t conceive of a “regular profit” in a thought-experimental ERE. This is because all events within the thought-experiment are periodic and known from the outset so anyone charging a profit would simply be undercut by someone else not charging a profit.
I don’t like the word “disequilibrium” here, I would prefer to use the word “uncertainty” because the difference between the ERE and the real economy is precisely that, uncertainty. There is no uncertainty in the ERE. Everything that happened before will happen again and all is known and predictable.
And yes, all entrepreneurial profit is the result of uncertainty. Because no one knows for sure what the future will be, the possibility of profit arises. You seem to be reversing causality and want to talk about a “chance to make profits” in a perfectly certain world (the ERE) which is absurd. You have to have uncertainty in order to have the possibility of profit or any action at all.
I’m pretty sure this is incorrect, can you provide the quote? Break-even has to do with a specific firm whereas a lengthening of the production process has to do with all firms.
Can you then tell me what Hayek is talking about in the schemes A and B in Paradox of Saving? My conclusion is based on what he is aiming to debunk: Foster and Catchings’ theory that savings would cause investment in production to be more than the money spent on buying the produced consumer goods. Hayek replies by saying that the savings would be used to improve the capital efficiency of the production in such a way that goods are produced with those capital goods over a longer period of time and thus help in breaking-even.
See what Hayek says:
“The allocation of the additional means of production has been
effected by maintaining the equilibrium between costs of production
and the prices of consumption goods in such a way that the
money stream has been lengthened and narrowed down correspondingly,
i.e., the average number of the successive turnovers
during the productive process has risen in the same ratio as the
demand for means of production in relation to the demand for
consumption goods has increased.”
@Prashanth: To be honest, I haven’t read any Hayek to speak of so I really can’t answer that question. I also don’t own the book so, unless the passage is available online, I can’t take a look to try to see if I can make out what he’s saying. There are some lurkers here who might be able to answer your question… folks, can you help Prashanth?
I might not be correct. But I don’t realy see how increases in savings would cause investment in production to cost more than the produced goods could sell for, ie how increases in savings could make production non viable.
Increases in savings within the market could have the potential to lower interest rates on loans because the more people that have savings the less demand there would be for loans and thus could cause a lowering of the interest rate. ie the less demand for money (loans) the lower the interest rate.
To be honest, I haven’t read any Hayek to speak of so I really can’t answer that question. I also don’t own the book so, unless the passage is available online, I can’t take a look to try to see if I can make out what he’s saying.
“The rate of originary interest directs the investment activities of the entrepreneurs. It determines the length of waiting time and of the period of production in every branch of industry.”
Of course it is absolutely correct. But what determines the interest rate? Time preference, purely and simply! The Gross rate of course is the orginary rate + premiums of all kinds (inflation, risk of borrower, etc…) but saying that interest rate affects time preferece (what can “propensity to invest” possibly imply?) is sheer fallacy.
@DD5: So, in your view, ABCT says that the interest rate does not affect investment levels but, rather, investment levels affect the interest rate? How does the central bank alter investment levels?
You are a confused. That’s according to the pure time preferece theory of the interest rate. Not ABCT.
ABCT describes the intertemporal distortion in the capital structure that occurs as a reult of tempering with this rate. It is precisely because the natural interest rate is determined by the amounts of investment (and never the other way around) that the distortion in the capital structure occurs. If it was your way, then the Kenyesians would be correct with their “gas and brake” view of the economy.
So what do you think Mises in that quote meant by “amount of savings are NEVER determined by the interest rate but the other way around…” Do you think he had a typo (in so many places) and actuall meant “always” or “sometimes”…? and then Rothbard carried over all those typos into his writings also? Just curious..
But the quote you just said was “absolutely correct” specifically says that interest directs investment activities. If you can tell me how a
can direct b, yet not have an effect on b, I’ll be pretty amazed.
How exactly does a tampering with the interest rate cause distorion in capital structure if the interest rate has no effect on investment levels?
Never? So one’s decisions to invest or consume can never be based on the interest rate? If I’m trying to decide on whether to put my money in the bank or consume it, the interest rate has no bearing on my decision?
EDIT: To be clear, I understand that there would be no interest rate prior to any savings, so the origin of investment must be the discount of future goods on present goods. What I don’t understand is how that truism precludes the effects of the interest rate on a potential consumer/investor.
The economy employs more technically efficient, capitalistic (“roundabout”) methods of production as a result of a lower time preference (higher savings rate) precisely because the interest rate falls. In other words, the shift towards a different method of production is the result of changes in interest rates. Also, and I just want to make this clear, the decision to employ more/less capitalistic methods of production is not an entrepreneurial decision that any individual firm makes. It’s not like businessmen say to themselves, “there’s a lower time preference, I can now employ more roundabout, profitable methods of production!” The structure of production (macro-economy) is forced to expand as a result of a lower time preference.
The same amount of producers cannot produce goods of lower orders and remain in business; again, they are forced to redirect towards remoter productions.
Also, and I just want to make this clear, the decision to employ more/less capitalistic methods of production is not an entrepreneurial decision that any individual firm makes. It’s not like businessmen say to themselves, “there’s a lower time preference, I can now employ more roundabout, profitable methods of production!”
Esuric,
Would you kindly provide a source or argument for this assertion?
With questions like these I suggest you read Hulsmann’s Structure of Production which is a radical alterantive to the standard Austrian paradigm. I haven’t digested it all yet but it’s worth a read.
Never? So one’s decisions to invest or consume can never be based on the interest rate? If I’m trying to decide on whether to put my money in the bank or consume it, the interest rate has no bearing on my decision?
That question bothered me for a long time, and I think I have the answer.
The key lies in understanding what originary interest means. The easiest way to grasp it is to understand that originary interest is a magic number inside peoples heads. They get up in the morning and the number “5%” is inside their skulls. If we dig deeper, we find it is how much more they prefer to have something now than to have it a year later. “I like it now 5% more than later”, is what they are thinking.
That magic number residing in their heads, 5%, say, will now determine whether they lend and/or save and/or invest. If they find someone who will give them 5%, they will lend it to him. If they see they can get a profit of 5% a year from now by investing, they will do it. If no avenue at all will get them 5%, they will spend their money right now.
Someone who borrows money also has that same magic number inside his head influencing his decisions. How that works is a bit complicated apparently, and I’m working on it.
We are now ready to answer Jargon’s question. Of course, if you are trying to decide whether to put your money in the bank or consume it, what the bank is offering will have a direct bearing. If they are offering above your [predetermined] magic number, you will put your money in the bank. If not, not.
This magic number understanding will also explain an incredible contradiction in what Mises wrote. On the one hand, he writes:
…the rate of originary interest… determines both the demand for and the supply of capital and capital goods.
Meaning if the interest is high, there is more capital made available for investment, meaning people will decide to put their money in the bank and/or lend it to someone.
Then he writes just the opposite, in the very next paragraph:
People do not save and accumulate capital because there is interest.
What gives?
In light of the magic number explanation, the first line we quoted is clear. What he means in the second line is this: People do not save and accumulate capital because there is interest [i.e. a magic number in their head].
Interest [= a magic number in someones head] is neither the impetus to saving nor the reward or the compensation granted for abstaining from immediate consumption [because all it is is a magic number in someone head, as he says in the very next sentence]. It is the ratio in the mutual valuation of present goods as against future goods [= magic number in someones head].
Of course, getting 5% from the bank is an impetus to saving. And of course getting 5% is a reward and a compensation for abstaining from immediate consumption. But those are consequences, not defintions, of originary interest. In addition, those consequences will NOT determine how high or low will be the actual percentage the bank offers. The defintion of originary interest, and what determines the amount, is the magic number in peoples heads, and that number is the ratio of mutual valuation of present goods etc. And that’s what he means in the second quote.
