Okay, ladies and gentlemen, it is my pleasure to begin today's program by introducing the F.A. Hayek Memorial Lecture.
Dr. Robert Murphy earned his Ph.D. in economics from NYU in 2003.
He then served as visiting assistant professor of economics at Hillsdale College in Michigan.
From 2006 to 2007, he was employed as a research and portfolio analyst with Laffer Associates, an economic and investment consultancy firm.
Currently he offers private economic consulting services including commodity forecasting, monetary exchange data and trade policy analysis.
Dr. Murphy is an adjunct scholar and frequent speaker at the Ludwig von Mises Institute.
He writes a column for townhall.com and has also written for lewrockwell.com.
He is an adjunct scholar at the Mackinac Center for Public Policy and economist for the Institute for Energy Research.
He has published three books including Chaos Theory, The Politically Incorrect Guide to Capitalism, and most recently The Politically Incorrect Guide to the Great Depression.
He has also designed the home study course in Austrian Economics and the study guide for Murray Rothbard's Man Economy and State, both of which are published by the Mises Institute.
He will address us today on the subject of pattern coordination and the theory of interest.
Please join me in welcoming Dr. Murphy.
Well, thanks for that introduction, Joe. Thank you all for coming. When Joe invited me to
give this lecture, he said in the email, I said, yeah, this is the name Hayek Lecture,
so you know, I want you to talk about your research and as it pertains to the work of
Hayek. And so, of course, my first thought was, well, I've been a consultant for four
years, what do you mean research? What is that? And what I'm going to do though is go
Go back to my dissertation, the third chapter from that, and talk about it. In the beginning,
I'm going to go off on what will seem like a tangent to you, just to lay the foundation,
but I promise I am going to come back and I will make it pertain to the work of Hayek.
And also, I'm going to stop at around 45 after to turn over Q&A, because I'm hoping this
is going to be controversial to some of you, that I am going to be challenging the pure
or Time Preference Theory of Interest or at least the certain expositions of it.
And so, like I said, I just hold tight and, you know, you might get antsy halfway through,
but don't worry, we'll come back and I'll allow you to voice your displeasure, okay?
Also, David Gordon fed me a few jokes beforehand, one of them I can actually tell.
He said, he told me to get up here and tell you that an economist is someone who didn't
have the personality to become an accountant.
And then he told me another one about Liberace, which you'll have to ask me about afterwards.
What I'm actually talking about, where this is coming from, this is chapter 3 of my dissertation,
and it's a monetary approach to interest theory, and what that means is in contrast to a real
approach, because the Austrians, pure time preference theory, it's a real approach to
interest, meaning we don't think about it in terms of money, when we say what's interest
about the Austrian boom they go right into oh it's time preference they talk about present
goods are more valuable than future goods and you never even talk about money after
the first sentence right so what I'm saying here is I don't think we should do that I
think maybe that's wrong maybe it's more realistic and we'll see we don't lose anything if we
acknowledge no what interest is it is has to do with money right that what you're doing
in an interest exchange the nominal rate of interest is saying if I lend you a certain
amount of money today, how much are you going to pay me back? Or an equivalent way is to
say it's the price of renting money, right? So some Austrians steeped in the, I'm going
to say PTPTs, or pure time preference theory, Austrians coming from that traditional, like
to even say interest is about the rental price of money, that's anathema. No, no, no, it's
not about money at all, it's about real goods and you're missing the boat, they would say.
You're missing the essence of interest. So again, I just want to, that's where I'm going
with this analysis here.
This, I don't have the URL for you, but if you Google, you know, my dissertation is online.
I actually get people at the Jekyll Island conference, a guy came up to me.
He's like, Dr. Murphy, I read your dissertation.
I said, oh, that makes eight of us.
And then I said, you know, of course, did you understand it?
And if he says yes, then I say, okay, you know, you're different from my committee then.
And now, if they see this online, I mean, they can't take away my PhD, right?
like I'm okay and I don't have to apologize so so anyway this this is online if you want to go see it now the the chapter two of the dissertation is a critique of the pure time preference theory whereas this is you know I'm sure giving you like what could Austrians use instead of it and I realized before I don't think I've when I was trying to decide what to talk about today the read part of the reason I said I said all this is I don't think I've presented on this material from this chapter three I've I've talked about
about, at least in formal sessions, about my problems with the pure time preference theory,
and I think I even tried to get it published, and it was hitting a brick wall, and I realized
part of the problem is you can't beat something with nothing, that it's fine to sit there
and criticize the problems with what I think are Mises' exposition of the P.T.P.T.
Again, for people coming in late, I'm not talking about T.P.s, things that Native Americans
love, I'm talking about pure time preference theory, P.T.P.T., I just realized if someone
So anyway, that's why I realized it's hard if you're criticizing something and people
could say, okay, yeah, yeah, yeah, but so what?
So now I'm hoping maybe if I show you the alternative, like this is a completely consistent
Austrian way to think about interest theory that doesn't violate subjectivism or anything.
In my opinion, this is actually more Austrian, if you will, than the PTPT.
So anyway, that's partly why I chose this, is because I don't think in this crowd I've ever actually shown you, you know, what can we do if we throw out the PTPT?
Okay, so let me, first of all, just very briefly just give you a few problems with so-called real theories of interest of which the PTPT is just one example.
So the first thing, and again, all this stuff I'm kind of saying from an Austrian point of view.
Alright, so a lot of the criticisms I'm going to raise, a mainstream economist wouldn't care, but I'm saying Austrians ought to care about these things.
So the first thing is that to even use a real theory of interest, you have to have in mind some sort of constancy or stationarity of the situation,
either of the economy itself, the conditions of production, or of preferences. So let me just give you an example.
In case you can't see it in the back, it says one present apple for one present orange,
one present apple, two future apples and so on.
The bottom one there is one future apple for one quarter future oranges.
So what this is, the situation I have in mind here is a real simple economy.
Apples and Oranges, two periods, and the story behind this is in the first period, the supplies
of apples and oranges are such that the spot price is one to one, alright, so if you want
to think that there's the same amount of apples and oranges and people, you know, don't have
a preference for one versus the other, other things being equal, you can do that, but you
don't need to.
The point is, apples and oranges trade one for one in the first period, if you want to
think of it in terms of money, you know, the spot price of apples is a dollar a pound in
in the first period in the spot price of oranges is a dollar a pound, okay? So they trade one
for one and then people know in period one they can see this coming so it doesn't take
them by surprise. They know the supply of apples is going to go up in the future and
they know the supply of oranges is going to go down, alright? So maybe there's some kind
of blight that affects orange trees but not apple trees and they can see in period one
that this is coming so it's not a surprise. So these are equilibrium arbitrage free exchange
and I'm not going to prove it to you here, but you can't make a pure profit in this environment, you can't do an arbitrage and buy apples in one period and futures and do something to make money risklessly.
So the question is, what is the real rate of interest in this economy? And I'm going to say it's undefined, you don't know.
If you look at it in terms of, because what does the pure time preference theorist usually say?
He says, oh, the real rate of interest refers to the premium on present versus future consumption.
So how many future goods does a present good trade for?
So here, if you just look at the apples, you'd say, oh, the real interest rate is 100%.
You give up one present apple, you know, there's different ways you can think about it.
You can say you sell it for money and then lend the money out, and then in period two, you would get enough money back to buy two apples at that point.
So you gave up in period one you give up one apple to get two apples delivered in
period two or if there's futures markets in period one you give up one apple and
that has the same market value is two claims on a future apple and you see
that here because the second line from the bottom one whoops sorry no let's
see the the second line from the top sorry one present apple trades for two
to future apples. That's what that means. So there, no problem yet, present goods are
more valuable than future goods. And you say, okay, but if you looked at oranges, it's the
opposite. The real rate of interest would be negative 50%. And so, now again, I can
see some of you getting antsy, and you're saying, but they're different goods. I know.
Just wait. I'm going to come back. So the point is, here, you couldn't point to the
premium on present goods because it's different across goods. And I just exaggerated, of course,
What if I had something more plausible, like there was a 10% premium on apples and a 9%
premium on oranges, then what would the real rate of interest be, what would the premium
on present goods be, and it wouldn't be obvious how you would compute it.
Now in Rothbard and Mises, is there a robot that's getting mad at me?
From Rothbard and Mises, the way they deal with this is they say that there will emerge
a uniform rate of return, that they'll say if investors could earn more in one line of
goods in terms of the real rate of return in that line, the rate of interest in terms
of the goods themselves, then they would shift into that line, that would push up the present
price and it would push down the future price okay and so that that would even it out right so that's
the that's they say that there were in you know in equilibrium there would be a uniform
premium on present versus future consumption across all lines but that's only true excuse me
that's only true in an evenly rotating economy okay because here again that's not that there's
a surprise here it's just the conditions change specifically and i have to move on because there's
There's a lot of ground I need to cover here, but specifically what's going on is the spot
price of apples and oranges changes from period one to period two.
Whereas Rothbard, when he goes through and tries to prove that entrepreneurs seeking
profits will tend to iron out all the differences, that only is true or that proof requires the
fact that the spot prices of all the goods are the same period after period.
So if you're in the evenly rotating economy, it's true, there will emerge just one rate
of premium on present over future consumption.
So that's the issue here.
So again, what's my point that to even talk about the real theory of interest, you have
to have some sort of constancy in mind.
So in this case, the constancy I'm pointing out is Austrians are thinking that spot prices
are the same, or at least the ratio of spot prices on real goods are the same period after
period.
The Theory of Money and Credit The Theory of Money and Credit
The Austrians aren't equipped to deal with that. They talk about the rate of interest in the evenly rotating economy.
Okay, now one thing that mainstream economists will do, and I'll just go over this very briefly,
the way a mainstream economist deals with that issue I just talked about is they'll construct a consumption basket.
So they'll say, yeah, if you just define apples as the consumption good, then the real interest rate is 100%
He puts it in the bank, it builds up, and then after the 10th year, he goes and buys the latest computer, like, you know, the cutting edge line of his favorite brand of computer. He buys the newest model.
It's hard to even think of, you know, the exchange there, the, you know, giving up present consumption for a future good, which is what he's doing for the 10 years that he's saving.
Postponing Potential Present Consumption in exchange for what at that time is going
to be a future good, but that future good doesn't even, it's not even available until
the day he buys it, if he buys it when it first comes out.
Okay, so you see there, it's, you get, I can't go into it here, but it's really, even philosophically,
it gets a little bit weird when you're trying to compare things when the composition of
the consumption basket changes over time.
Okay, so again, I'm just pointing out you get into trouble if you try to think about interest is a real phenomenon as opposed to
No interest is has to do first and foremost with money at changing hands intertemporally
Okay, another
Way, let me to try to get you to see where I'm coming from when I say that this is in my mind
It's more Austrian to look at interest as having to do with money is look at this quote from David Laidler
In the economics of Keynes, as in classical economics, money was a means of exchange, and textbook macroeconomics even now refers to transaction
Actions and precautionary motives for holding money, which are said to derive directly from
that role. However, when monetary economists adopted well-raised and general equilibrium
as their basic vision of economic activity, they adopted a model that could not generate
such motives internally. The monetarist counterrevolution did nothing to interrupt the process of integrating
monetary theory with well-raised and value theory. The further this process was pushed,
the more the representative model of a monetary economy came to resemble one of a barter economy
in which there happened to be a peculiar asset called money
whose real, in other words, utility-yielding quantity
varied in inverse proportion to its price in terms of goods.
The utility in question was said to arise from money's role as a means of exchange, of course,
but there was no such role for it to play within the logical structure of the
representative macroeconomic model.
So there, Lathur is criticizing mainstream economics macro models
where, I mean, for those of you who have studied these things, you know exactly what he's talking about, that
it's a barter economy, there's usually a representative agent, they have utility function,
but then they want to put in,
you know, and the agent knows all the prices and he knows the structure of the model, if there's
uncertainty, it's just, you know, some random variable, he knows the distribution of it and that sort of thing,
so there's rational expectations,
and then, but the problem is, if they want to discuss, you know, central banking policy,
They have to have money in the model, right?
And so how do they get it in there?
They'll call some good, the numeraire,
and then they will say, well, let's just assume
that holding this thing gives the agent a flow of utility,
that they get utility from having this thing
as part of their cash balances,
in the same way that if you had to model an agent
buying a painting, you just have that as a parameter
in the utility function, and just say,
well, the more paintings they have hanging around their house
in their possession, the happier they are,
in the world of the model, there's really no reason they need to have money, and I think
if you didn't know the context here, and I were just making fun of mainstream economics,
talking about this, you'd all be agreeing with me and say, yeah, you're right, that's
silly that they don't understand why people are holding money the way we Austrians do,
and they're models, there's not even a role for money, and so that's the problem with
mainstream economics is they make a bunch of assumptions and then try to talk about
Central Banking Policy in a world where money doesn't serve any functions, of course, the
answers are going to be nonsense. But what I'm saying is that's what the Austrians are
doing with interest, that you're thinking of it in terms of an evenly rotating economy,
and you're thinking of it in terms of, you know, you're not even dealing with money.
And so that, you know, the world in which the Austrians think, to think through the
implications for interest theory is a world where you wouldn't need money. And so that's
a little bit weird that, you know, what does money have to do with? Well, surely it has
has something to do with money and interest, or have to do with each other because interest
is the rate of return on money when you lend it.
And so the way I summarize it, I say that looking at the world in terms of a barter
economy always abstracts away from one side of real world transactions, right?
In mainstream economics, when we use compute marginal rates of substitution and so on and
and solve price ratios without having money actually in the model, you know, that abstracts
in the real world on one half of each side of every transaction because in the real world
you're usually buying a real good for money, but when you do that with interest, it's abstracting
from both sides because in interest in the real world, you're giving up money in exchange
for future money, and so it's really odd if you're analyzing that with a model where money
doesn't even play a role, okay, alright.
So now, so we see what my concerns are with the real approach, so what would it look like
for a monetary approach. Well, let me talk about, again, it's going to seem like I'm
going off on a tangent here, but just trust me, it'll be relevant. I want to go on an
excursus on subjectivist methods, so I just want to walk us through some familiar examples
and how we use subjective value theory or price theory, and then we'll see that the
the way we use it in an intra-temporal context
is inconsistent with how Austrians use it inter-temporally, okay? So, the first thing is
let's say we've got
two different goods
Okay, so a physicist comes along and there's these two things, these two distinct items,
and he says, I've done the measurements and that first thing, it's 8.01 ounces of spring
water. And then he said, and that other thing over there, that's 8.02 ounces of spring water.
And so the physicist wants to say, those are different things. But as an economist, we
We know those could be the same good, right, because the consumer, as long as, you know,
the consumer doesn't really distinguish between those decimal points, if you follow what I'm
saying, right, that, you know, if you're holding up two bottles of water to a consumer, and
they might think the same thing, it doesn't matter if a physicist comes along and says,
no, actually they're different, right, okay, because again, it matters, it's in the consumer's
head, all right, and the same thing if you have, you know, if you're trying to, as a
The Social Scientist understand what's happening in a Catholic service and a chemist comes along and he says, you know, they're holding up this chalice of wine and this guy did some stuff, but I analyzed it and chemically it was the same before and after, but yet everyone was acting different, you know, after he did these motions with his hand, what's going on? And you would say, oh, because these people, you know, have certain beliefs and they think that something changed, you know, what was wine turned into something more sacred to them. And so it doesn't matter that you can't see any physical difference.
And to them, in their minds, it is a different thing now, and so they would sacrifice something
much more to preserve the thing after it's been blessed than beforehand.
So again, as a social scientist, trying to understand their actions, we see in both cases,
it's not the physical characteristics, it's what's in the people's heads.
This is the standard stuff.
But you might say then, okay, so if something is, from the wine example, turning into, in
Catholics' minds, turning into the blood of Christ, you might say, okay, so if something
has different amounts of value, then they're different goods to the people subjectively,
But you've got to be careful, because what about this example?
The nth unit of water, as opposed to the n plus 1th unit of water.
Okay, now in standard Austrian theory, you know, the marginal utility of that second thing is lower than of the first and so in that sense they're different goods but yet they're both units of the same good, they're subsequent units, okay?
So what I'm saying is, you know, how do we distinguish between saying the fifth gallon of water versus the sixth gallon of water as opposed to saying the fifth gallon of water compared to a diamond ring?
Because those are clearly different goods too.
And if you say, well why? You say, well it has something to do with subjective valuation.
And the same thing though with the fifth versus the sixth gallon of water, why are they different?
Well it has something to do with subjective valuation, but yet there's a sense in which the fifth and sixth gallons of water
are the same good, they're just different units of the same good, whereas the gallon of water and the diamond ring, they're totally different goods.
Okay, so how do you resolve this? What's the common element through all this?
And I want to say, I propose in the chapter that is the, I call it a swap test, meaning
if you could take these two things that might be physically distinct, that a chemist or a
physicist could point out the differences and just swap them, that the consumer wouldn't
care.
Alright, so when you have, you know, one gallon of water that's devoted to drinking and a
A different gallon of water that's devoted to washing dishes, technically they're not
the same thing, right?
That the physicists could say, actually this is 1.01 gallons and this is 1.02, but as long
as the consumer wouldn't mind if you switched them so that this water over here now is the
one devoted to drinking and this is the one devoted to washing dishes, the consumer doesn't
care, that's the sense in which they're different units of the same good.
It doesn't mean, of course, that the consumer values the first and the second gallons the
Okay, so now the issue is, let's think about a different example.
What about this one?
Orange in Maine versus an orange in Florida.
So here the context I have in mind, standard free market economics, you have somebody complaining
about middlemen and they'll say, all these people, they rip off the farmer because they
buy the good as the farmer grows, he puts his labor into it and so forth and they buy
it in Florida for a certain price and then they take the same thing and they move it
up to Maine and they charge a huge markup and they're ripping consumers off and they
should be paying the farmer more and charging the consumer less.
So as a free market economist, what do we say to that? The obvious thing is that those
are different goods. An orange in Maine is not the same thing as an orange in Florida,
and a guy in Maine is willing to pay more for an orange in Maine than a claim to an
orange that's all the way down in Florida, because obviously he can eat the thing that's
sitting right there in Maine, but he can't eat the one in Florida. So again, these are
different goods, but if we push it, they're different goods, but they're not different
or they're different in different ways.
Right, those comparisons that, yeah, an orange in Maine is also a different good from a diamond in Florida,
but yet, you see there's a sense in which those are more different, if you will, than the first two things.
Okay, so again, I want to propose what we have in mind is that swap test,
where, you know, what we mean is those first two things, they're saying they're both oranges,
and again, it's not that they're physically the same orange in terms of the atoms and whatever,
that no, what we mean is you have an orange in Maine and a different physical thing that's down
in Florida, and if we somehow magically swap them, and then the consumer wouldn't care, you know,
he's about to eat his orange for lunch in Maine, and we swap that physical thing with another
sphere that's down in Florida, and he wouldn't notice a difference, that's the sense in which
Okay, we're talking about the same oranges, and the only difference is this one is in
Maine in your hand, and the other one is down in Florida.
So what we're doing is we're holding everything except the geographical location constant.
And that's the sense in which we're saying it's the same good, but for the location.
And then we say, yeah, once you factor in the difference in location, they are different
goods.
There's no doubt about that.
But they're the same good except for that.
Whereas the diamond in Florida and the orange in Maine are also completely different goods,
But there's a sense in which, you know, if you swap them, obviously, you know, if you
want to eat something, you're not going to eat the diamond ring, and of course, you can
go sell the diamond ring or give it to your wife or whatever, and she's going to be a
lot happier than if you give her an orange, right?
So, and I've tried that for my anniversary, and believe me, okay, so you see the issue
here, okay?
And again, I'm just walking through, I just want to point something out, it would never
Never come up in this discussion when you're trying to argue with somebody who's complaining
about middlemen and you're trying to explain what subjectivist value theory says, you would
never ever be comparing the psychic satisfaction and asking the person, would you rather eat
an orange in Maine and you're picturing that, you know, how it tastes in that psychic experience
versus you being down in Florida and eating an orange down there, right?
That never comes up.
Here, the person is always in Maine, it's the same person, same value scale, and the
question is just, you right here in Maine, do you want an orange here in Maine, or do
you want to claim to an orange that's, you know, thousands of miles away? I'm bad at
geography, I don't know. Very far away. Okay, you see what I'm saying? You're never asking
the person, would you rather eat the orange here in Maine, or would you rather be down
in Florida eating the orange down there? That's not really relevant to this kind of issue,
okay? So now the connection with the pure time preference theory, the way Austrians
The Austrian say present goods are more valuable than future goods and then there's all sorts
of obvious counter examples that come up and people will say something like, okay, well,
you're talking to a guy in the winter and you said you want some ice cream now or do
you want it next August?
He might choose the August ice cream because, you know, for obvious reasons and so isn't
And then a case of a guy in winter preferring the future good to the present good and the
Austrian says, no, those are different goods. But what they mean is they're comparing you
eating the ice cream there in December versus picturing yourself eating ice cream in August
and you're comparing your happiness of that future guy with your happiness right now.
So you're doing the equivalent of, you know, saying the guy eating the orange in Florida
Versus the Guy Eating the Orange in May, all right? And so it's, again, it's, I have to move on here, but that's what I'm getting at, that it's, it gets a little bit weird in the way we have to discuss things. It's not consistent with how we do it in an intratemporal context. To give you just an example, and this goes back to the earlier point about I have to assume Constantine preferences. Suppose you're talking to an eight-year-old kid and you say, hey, do you want a bottle of beer? No, sorry. Do you want
Do you want two bottles of beer now, or do you want one bottle when you're 25 and in college, or sorry, 22 and in college? Hopefully the kid's not still in college when he's 25, right?
And if the kid is, you know, if he's a normal kid, not growing up in some family like mine, he's an eight-year-old, he's not going to drink beer, right?
Because he's going to say, that's gross. And if he's, but if he's wise, he'll say, you know, I've seen other people, and as they age, they acquire a taste for beer, and so I probably would like beer when I'm 22 and in college.
And so yeah, I'll take your claim, your airtight claim right now to a beer when I'm 22. So
there, it's really weird. So first of all, the critic of the PTPT might say, well, duh,
isn't this an obvious case where the person is preferring the future good? They're giving
up a claim, or two cans of beer in the present for one, years in the future. Clearly this
person prefers future to present goods. And that would be very consistent with preferring
How does the PT-PT theorist get around that? Well, no, they're different goods. The subjective
satisfaction to you in the future is different from right now. But again, that's really
is really weird because you're not just allowing time to pass, but you're having to take into account that your preferences themselves will change.
And so you're comparing, you're basically doing an interpersonal utility comparison.
Right? You're comparing the happiness to this one guy today, this eight-year-old kid, and then comparing it to some 22-year-old kid.
And so I'm saying if you're allowed to do that as an Austrian, then why can't we talk about, you know, right now there's an eight-year-old guy here and a 22-year-old guy here,
and I give him the beer and him the beer and I say, oh, he gets more utility from that than this guy does.
And as Austrians, we say, no, he can't do that. That's an interpersonal utility comparison.
But yet we have to do that in the pure time preference framework to deal with these sorts of examples.
Okay.
So what I'm proposing then is that if you want to talk about it in terms of interest theory,
You can do things like this, you can talk about orange in 2010 versus orange in 2011, and
what do we mean by that?
It's the same thing we meant with the orange in Maine versus Florida.
In orange in 2010, to say it's the same good except for the difference in time, we just
mean if we had the thing right here in 2010, and I'm going to give you a claim to something
by saying the same good, which is what the PTPT people have to say. You don't do that
at all. You're talking about the same guy, same value scale right now, and you're just
saying if you somehow magically had a time machine and switched these things, would they
be the same to you? All right, so I'm saying that's consistent with how we deal with stuff
in an intra-temporal context. And so there, if the person, if you say, now I've given you
a choice between these two, which do you prefer? And if the guy says, I want an orange in 2011,
then okay, that's an example of a future good being preferred to a present good. And you
And you know, that's no big deal, the world doesn't blow up, you don't become a communist
if you say that.
You know, it's not that interest all of a sudden is cast into suspicion.
You could prefer an orange delivered in 2011 to 2010, what's the big deal?
Just like if somebody said, I'd rather get an orange in Florida, a claim to an orange
in Florida, as opposed to one in Maine, that wouldn't upset our price theory.
It's not like all of a sudden, if someone said that the income of middlemen would be
If we were to be cast into doubt, we would just say, okay, that guy has unusual preferences and that's not normal, but typically people prefer goods to be close to them, right?
You wouldn't need to come up with a theory of proximity preference and say other things equal, people want goods to be closer than farther away and that's why middlemen earn an income and that's why it's justified.
You don't need to go into all that. You just talk about people's preferences and say empirically this happens to be the case and that's why middlemen earn an income.
And if that weren't the case, if people weren't willing to pay more for goods typically that were available to them in their state than a good that was produced several states away, then the middlemen wouldn't be able to earn that income, you know, so it's not an issue of the government coming in and having to regulate it.
So again, I hope you're seeing the analogy there that I can concede that there could be someone who would prefer a future good to a present good, and that doesn't mean all of a sudden I can no longer justify interest payments or explain why the market interest rate is positive.
Let me move on to a few other loose ends and then I'll stop it for your questions.
So the other thing that I dealt with in the chapter is this notion of radical uncertainty
and again I know there's certain elements in this that some Rothbardians don't like
but I think there's a lot to be said for this.
I don't agree with everything these people are saying.
Some of them I think do take it too far to become sort of nihilist but I think there's
There's a lot of truth in what they're saying, and I'm not going to be able to develop it here, but it's things like, you know, Hayek has this great quote where he says,
the mind cannot foresee its own advance, alright, and if you've seen, the way I would explain this to undergrads by this point, usually they would be passed out, so I'd bring them back, and I'd say,
and I said, fortunately, you guys are at least, you're still not nodding off, they would say,
it was in Max and magazine, but I think it was elsewhere, I don't think they invented
it, but it was like Hayek versus Hayek, so it was Salma Hayek versus Friedrich Hayek,
and you know, they were doing head to head on various issues, and so one of them was
like Beauty and they had a picture of Salma and Friedrich and said, advantage Salma, right,
and then it was going through there, and one of the categories was philosophical depth,
And then it said, Friedrich, and that's where it had this quote, it said, the mind cannot
foresee its own advance, and then for Salma, it said, I want to meet a man who has bigger
balls than me, and then the thing said, advantage, Friedrich, you know, so.
Anyway, I usually got the undergrads, they're like, what's this, okay.
All right, so anyway, so what is he talking about there, I mean, I'm not going to go
into it here, but Carl Popper has some really neat little discussions on this, sort of saying
The insight or the intuition is, you can't right now know your future knowledge.
You can't predict your future behavior because your future behavior is going to be influenced
in part by what your beliefs and knowledge are at that time.
So in order for you right now to know for sure what you're going to do in 2011, right
now you would have to know your knowledge in 2011, but you can't know your future knowledge
because if you did it would be present knowledge.
So it's that kind of neat little philosophical trick there.
So if you can see that people do learn, well then you obviously, you can't predict the
future with certainty.
Okay, so then, all right, that's a neat little trick.
So what?
What's the relevance here?
Well, the relevance comes in Hayek's notion of equilibrium in an intertemporal context.
So what is it?
It has to do with plan coordination.
And so Hayek talks about that, this is the example I used to give, if you're going to
go to a grocery store, for example, and you want to buy some milk, so your plan is, okay,
I want to make, I have a big party tomorrow, people are coming over, and oh, my fridge
is empty, so I have to go to the store, I have to buy some milk, I've got to buy eggs,
I've got to buy all this stuff, chips, whatever to put out, all the stuff that you need because
you're planning on having this party.
And so you're going to go to the store.
And so there's a lot of things you're assuming that other people in the economy have done.
You're assuming that their plans mesh with yours in some respect, that in order for you
to go to the store and you're going down the up, yep, there's some pretzels and here's
the eggs and the milk, and then you go up and you pay for the stuff, you had to, you're
implicitly assuming that there were other people in the economy and their plan was,
some guy woke up and he said, okay, today I have to drive the 18-wheeler from the warehouse
down to the store because I'm delivering a shipment of pretzels, right, because otherwise
how did those pretzels get on the shelf?
Somebody had to have done that.
And there's some other, you know, teenager waking up saying, oh man, I'm hungover but
I have to go be, you know, work my shift because I'm the cashier today, right?
So the kid that's ringing you out, you know, part of their plan was I have to go to work
today and work the register, all right?
So the idea is, what Hayek's talking about is, in an intertemporal context, what equilibrium
really means, it has to do with plans being in coordination with each other somehow.
And so it's not just that you correctly anticipate if it's going to rain or the laws of physics
and you know like, well gee, if we apply this much heat to the steel, it will become malleable
and we can bend it and whatever and we can produce these consumer goods, so you need
to be able to predict the future that way and to understand the laws of physics, but
you also need to predict, at least in some respect, what other people are doing and that's
to have true equilibrium, Hayek says, in an intertemporal context, there has to be some
sort of compatibility or these plans have to mesh with each other.
Okay, but then you run into a problem of, well, what about this issue of this radical uncertainty, where you can't know the future with certainty?
So, doesn't that kind of blow up this idea of coordination? And so here, what I did is I drew on the work of Rizzo and O'Driscoll.
Let's see. They talk about this term pattern coordination. So they say pattern coordination makes use of both the original Hayekian compatibility of plans
and the distinction between typical and unique aspects of future events. The plans of individuals are in a pattern equilibrium if they're coordinated with respect to their typical features even if their unique aspects fail to mesh.
And so the example they give is two people who are collaborating, two professors collaborating on a book project and they go and they meet in the one guy's office and they discuss, you know, what are we going to talk about in the book, what theme are we going to stress, that kind of thing.
and so Rizzo and Andrisco they say there has to be some notion of coordination there that if the one guy thinks they're meeting at 11 you know in the cafeteria the other guy thinks they're meeting at 10 down the student union the meeting's not going to work there's a sense in which we're going to say that's a disequilibrium but you don't want to push it too far it's not that professor Smith knows oh what professor Jones is going to say is this this this and this and then I'm going to answer this this and this because if they knew that there's no point in having the meeting right that if they know
I don't know exactly what the other guy is going to say and what their response is going to be.
There's no point in having the meeting because they already know it.
Okay, so what Rizzo and O'Driscoll are saying is there's a sense in which there's a pattern coordination
that they can talk about the big picture items, the typical features of what does it mean to have a meeting with somebody
without drilling down in the specifics of the content of what was said.
Okay, and then I gave a different example of a chess tournament.
And I said, you know, for the chess tournament to be well organized,
There's my alarm, so I'll wrap up on this point. For the chess tournament to be well organized, it has to be the case that if opponent Jones thinks he's playing opponent Smith at this table at this time, the other guy has to think the equivalent, the mirror image of that, or else it's not going to work out.
out. But obviously, you know, their plans, their coordination couldn't be such that he knows, oh, he's going to open with this move with his pawn, and then I'm going to open with this move, and so on, back and forth. They can't see the full game play out, because then they would already know who the winner of the tournament was going to be. All right, so you see that there's, and it would defeat the whole point of it. So anyway, what I'm saying here is that I use that notion for interest theory in terms of future and present goods. And I say that, what
What happens with money is we can define what future and present units of money are, and
then what does it mean for that market to be in equilibrium? It just means, I bring
up this notion of no regrets, and I say that people set aside a certain amount of cash
balances, not because they know exactly what they're going to buy with it. The money you
have in your wallet right now, it's not that you have every single penny earmarked for
something else that you're going to buy in the future, which is sort of what the pure
Pure Time Preference Theory pushes you to say. Pure Time Preference Theory, the reason
you want a positive interest payment, the reason you have to, you know, if you give
up $100 now and someone's going to give you $110 next year, the explanation for that according
to the Pure Time Preference Theory is, oh, because you want to consume now and so you
have to be, you know, paid to compensate you for having to defer your consumption until
next year. But I want to say it's also possible that you don't know what, you know, you need
that money, it's a liquidity preference. You don't know what you're holding it for, but
The Theory of Money and Credit
is, in a certain sense, but, you know, it's sort of like when people get mad at Ron Paul
and they say, like, oh, so you're, you're, you know, you're justifying the attacks of
9-11 or something. Well, no. I mean, you can understand where these people are coming from
without endorsing their policy conclusions. And the same thing here. I'm saying a lot
of what Keynes wrote in The General Theory, it actually, it's real deep stuff in it. You
understand what he's mad about, but then, you know, look what he did with it, you know,
and that kind of thing. It doesn't follow then that because he's having these concerns with standard economic theory of his day that therefore the government should nationalize investment and so on.
That's a complete non-sec order. It doesn't follow. So yeah, there is a sense in which a lot of what I'm doing overlaps with some of the stuff Keynes was talking about.
So let me just read you this quote from Keynes and it's kind of ironic because you'll see that what he's saying sounds very Misesian in a sense.
It has been supposed that any individual act of abstaining from consumption necessarily leads to, and amounts to the same thing as, causing the labor and commodities thus released from supplying consumption to be invested in the production of capital wealth.
The conviction, which runs, for example, through almost all of Professor Pagu's work, that
money makes no real difference except frictionally, and that the theory of production and employment
can be worked out, like Mills, is being based on real exchanges with money introduced perfunctorily
in a later chapter, is the modern version of the classical tradition.
Contemporary thought is still deeply steeped in the notion that if people do not spend
their money in one way, they will spend it in another.
So I like this excerpt because it's combining two things here.
On the one hand, it looks like he's saying, you know, you can have saving that doesn't
lead to investment, and we know that we don't like that because we think that, oh, that's
going to justify government deficit spending, and so we clam up.
But on the other hand, he's complaining about people who look at the economy as real exchanges
and then only later introduce money as an afterthought.
And he even uses the phrase, looking money, you know, just viewing it as a friction.
And that's, remember, I mean, Mises complained about that about Boehm-Bawerk, right?
So that's a very Misesian thing to be mad when theorists abstract away from money and
just look at the economy as real exchanges and don't really have a role for money as
its own driving force.
Okay?
So I'm saying that that's what Keynes is talking about in the context of interest and so rather
than just saying, oh, well, that's Keynes and I don't care about it, I said, well, maybe
we should look at that and say, yeah, money, the driving force of money and so forth and
money is its own thing and don't just introduce it perfunctorily in a later chapter after
we work out the real interest rate. Okay, so I'll stop there and turn over to your
questions. Yeah, David.
Okay, in principle I'm supposed to summarize what David just said. So he's made this point
Right here, it wasn't striking me, David, but I know at lunch last summer, you got me to see what you were saying and I agreed with you.
I think what you're saying is that Carl Popper's argument, it's not that he proved that we don't know future knowledge, it was just sort of a conditional thing.
If you had someone who was a complete determinist and who thought the future was already set in stone, there's nothing ruling out that possibility.
And so I think what David is saying is Popper and the Popperians thought that that argument proves more than it really does.
So I guess my response would just be, I think there's a sense in which we all agree people do learn over time.
And so, yeah, I mean, we're sort of just pointing to the counter example that we think exists.
Yep.
Okay so the question is what is money and I guess I was thinking at least in the
Austrian tradition I would say money is a universally accepted medium of
exchange that's the pat answer and and so it's I'm not sure I mean I guess that
Well, I mean, it just keeps score. It's a way of collecting information.
Let's pick gold and price everything in terms of gold or price everything in terms of sheep, which is what they do in a mainstream model.
Whereas Austrians normally would say, well, no, gold actually serves a function.
The economy is different because people started using money than if they never used money.
It allows people to discover trilateral exchanges and things to avoid the problem of the double coincidence of want.
The Presence of Money actually changes things.
Yeah, Paul.
Yep. I'm getting nervous. You're looking you're about to blow me up. And that's all the time we have for today.
or what end does that serve?
And I'm thinking that you're creating an example
in the vacuum and they're divorcing you
from the process of theory.
And I suspect that violating the parent-parent assumption
is at the heart of time preference here,
which is just a necessary condition condition,
not necessarily the whole reason for it.
Basically, why did you choose the orange in Florida?
and then Paul is asking me well don't we don't need to give you more information don't we need to dig in deep to why does he prefer the one in Florida and I want to say no that I don't think so I mean if we weren't in this discussion I don't think it would have occurred to anyone to challenge me there and to say well why does he prefer that you wouldn't care I mean why does he prefer the or in the normal case where you say he prefers the one in Maine to Florida what if he
What if he runs a deli and he uses it to make orange juice?
Well there it's a capital good, or if he just wants to eat it for lunch, it's a consumption
good, but that doesn't really matter why he preferred one or the other.
The question was just do you prefer this or not?
So yeah, for other reasons, if we want to dig into why does he prefer it in terms of
his subjective plans, we could do that, but no one ever would have thought to challenge
If I had told you he prefers it in Maine to Florida. I'm going to move on. You can argue with me later.
__________
I'm used to giving lectures to business people and whatever, and I talk about the Austrian business cycle, and they have no clue what I'm talking about, and their questions are real, you know, I just knock them out of the park, these questions are really tough.
Okay, so he's asking me, am I saying that interest is just a monetary phenomenon, like what happens in a barter economy before money emerges, and you know, there's people that, if you can see that there's a premium on present apples versus future apples,
And there, don't I want to say, yeah, that's kind of what's going on in our monetary economy.
It's just now that money is overlaid on that or, you know, money might change it, but surely
there's some real component to it.
Yeah, I, I'm not sure.
Let me just weasel out and say, I'm not sure.
I don't want to deny that, but I'm saying it works through money.
Okay.
That, yeah, there are, you know, you don't want to just hold money just for its own sake.
You want to use money to go buy stuff.
So I'm agreeing that there's ultimately your preferences for the real commodities in different
time periods.
That certainly plays a role.
But I want to just say that what is interest first and foremost is an exchange rate present
for future money.
And you said, you know, the apple for the future apple, yeah, but I would say at best
that's the interest rate on apples.
That again, what if in that same economy, the own rate of interest on pears is different?
You know, one of the apples is 10% and pears is 8% and you want to say, okay, but what's
the interest rate?
I don't know.
How do you define it in terms of money?
And I think Mises even says somewhere, like when it comes to, you know, calculation and
things like that, that I want, I mean, like, is it true you can really, profit only really
make sense if there's money?
Is that okay?
Even though you can, in a sense, a Robinson Crusoe world, you can, you can, there's some
analog that clearly there's an issue of using resources effectively, but I think Austrian's
push to the wire would say profit doesn't really make sense in a world without money.
I want to say interest, yeah, there's ghosts of it, if you will, in a barter economy, but I think it really only makes sense because what we mean by interest is it's the price of renting money.
Okay, one more. Yes, sir.
My question is, why is it that the interest rate coordinates the direction of the second order of goods and the third order of goods?
What happens if the reserve takes that out of the market? And explain to me, why is first rate the right interest rate?
and the Fed comes in and screws with the interest rate, doesn't that lead to the business cycle?
Yeah, you're right. I'm just going to concede that point.
Part of my trouble here is I don't want to give up the real Austrian business cycle theory.
That there we were talking about coordinating real things and we're not really even talking about money so much.
And so yeah, I don't want to let Bernanke off the hook.
But again, I think it's a more nuanced thing. There are lots of issues with liquidity and so forth.
The best thing, and I'll stop, is the Austrians, when we talk about, oh, what if all of a sudden people became really impatient, the interest rate should go up, right, and the Austrians, but what, I want to say, what if people all of a sudden become really uncertain about the future and their liquidity preference goes up, or if you want to use some other non-Keynesian term, go ahead, then the nominal interest rate could spike too, and if you're an Austrian PT-PT theorist, you're having to say, oh, I guess all of a sudden people became really impatient, and that's not really what's going on there. Okay, I'll stop, thanks.
Thank you very much.