This paper that Walter and I are doing, it's a working paper and it draws on some things that we've done in the past and attempts to bring them together.
Some of it is pedagogical, but it seems to me a pedagogical that has substantive implications and other parts of it seem to me substantive that have pedagogical implications for it.
A few years back, three, four years, I don't know, Walter and I published a couple of papers on what has come to be called, or what people call, maturity mismatching.
I don't like that term because maturity mismatching can be of different types and if you talk
to mainstreamers and all, if you look at the duration, the calculation of the duration,
you can have a situation where you have maturity mismatching, well it's okay because the asset
that duration is the same as the liability duration on our balance sheet, so that's
a big, you know, that's okay. But I'm always reminded of the story about the six-foot tall
man who drowned while trying to walk across the river whose average depth was one foot.
So, you know, we have that. Another thing that came up in this was the idea that borrowing
Borrowing $10 for one year is very, very different than borrowing $10 for 10 years. We tend to
measure credit in terms of the amount of money borrowed, but actually if you think in terms
of dimensions, credit has a time dimension as well. $10 borrowed for one year is very
different than $10 borrowed for two years. And $10 borrowed for one year is very different
than $1 barred for 10 years, and this problem comes up in the finance, I know Joe teaches
finance, you know, does some of that stuff with the MBAs, how do you compare two investment
projects that have the same net present value, but one has a maturity of one year and the
other has a maturity of 10 years? So, anyway, that gets us to the idea, and I'll be getting
The idea of maturity mismatching in the form of borrowing short, lending long, Walter and
I wrote a paper about that, as I said was published a few years ago, and if you think
about what's going on there, what's happening is that as long as that's legal, the private
sector is doing what the Fed is trying to do right now and has tried to do early.
The Fed in the early 60s tried Operation Twist, right, to drive down long-term rates and drive
up short-term rates.
They were doing it at that time for balance of payments and reasons, but also because
of the slow domestic economy.
But if you think about, if we have private institutions that are borrowing short, attending
to drive up short-term rates, but they take the money and lend it long, that turns to
to lower long term rates, obviously that has implications for business cycles from an Austrian perspective.
On the other hand, and again, you don't see that much of this, but if you borrow long
and lend short, then to my way of thinking, that has implications for growth, it slows
down growth because in that case, resources get diverted from long term projects to shorter
term projects and consumption.
That brings us to the idea that really it's credit expansion, not monetary expansion,
that is critical.
Monetary expansion, nobody's, if you think about it, Mises talked about the circulating
credit theorem, a theory of the business cycle.
He was not concerned with fiat money being lent into, excuse me, being spent into existence.
If the federal government right now is running these deficits, and just saying, okay, we're
running a trillion dollar deficit, let's just print a trillion dollars and spend it, well
obviously we would have huge inflation problems, and everybody understands that.
But it wouldn't cause a business cycle, certainly not of the Austrian style.
But it's when you lend new money into existence that it enters the economy through the financial
Market and distorts interest rates and that causes the distortion of the structure of
prices which then leads to the unsustainable distortion of the structure of production.
Now all of that leads us to think that, you know, if you start thinking about this then
you say, well, there's actually all kind of ways you can characterize financial institutions
But one way is to characterize them as brokers or dealers, where a broker merely brings together
the borrower and the lender and charges a fee or commission for the process, whereas
a dealer is a principal, not an agent.
A dealer goes in and borrows money from somebody and then relends it.
So if you think about a bank as a bank's a dealer, at least most people I know don't
usually think about that, but the bank sells deposits and then the bank takes the funds
it got from those deposits and buys notes.
So really to get a real handle on that, unlike these diagrams, the first one is the typical
The second one shows the typical comparison from the Austrian point of view of what happens
if there's an increase in the supply of loanable funds because people save more versus an increase
in the supply of loanable funds because of an increase in the money supply.
But actually, if you're going to show this kind of situation in the banking system, you
really need two figures for each of those.
Let me see if I can get to the next one.
One thing this leads us to do is to think that perhaps it would be more useful pedagogically
to get away from loanable funds models where the price of the loanable funds is the interest
Interest Rate, and you have a demand for loanable funds and a supply of loanable funds,
but loanable funds are money, and the price is an interest rate? Far better to put it
in terms of financial assets, where you have a demand and supply for financial assets,
not in terms of an interest rate, but in terms of a price, right? And of course, the price
This then is a real money price. It's so many dollars for a bond or whatever it is. So that's
one of the things where we think there's something to do both where the pedagogy and the substance
are linked there and we need to do that.
The next thing that we thought about was that the standard model that we use when we're
talking about growth in the Austrian model is, we say, well, growth comes about because
of a decline in time preference, which leads to an increase in saving, which reduces the
interest rate, and we get an increase in investment, but it's not an increase in investment, it's
using the typical language or the standard language, it's an increase in the quantity
demanded of investment. We slide down the investment curve. The supply of savings shifts
out and we slide down the investment curve. In point of fact, I do believe that history
would show and reality shows, and obviously Schumpeter agreed with this and all that,
but the dynamic force for growth in the economy is not the household and not the consumer
who is increasing savings, perhaps because wealth is going up or whatever, but the dynamic
force in the economy is the entrepreneur, and the entrepreneur sees opportunities for
profits and shifts out the demand for loanable funds, okay, and when they shift out the demand
for Loanable Funds, then the quantity supplied of saving obviously rises to meet it.
So in either case, with either one of those models you use, whether it's the increase
in saving or the increase in investment, they're both going to end up, the actual quantities
have to be the same.
Saving and investment in the real world are the same thing, okay, so they have to be the
the same thing, but the model, thank you, Joe, the model where the demand for investment
or the investment demand curve shifts out, if you look at the new equilibrium at the
higher quantity of saving and investment, interest rates have gone up.
And we all know that everybody in the financial world, everybody in business understands that
as soon as they think there's going to be growth is coming, interest rates go up.
Why?
Because the demand for investment funds are going up.
So we think that that's both pedagogy to show what's going on by saying, look, it's not
the increase in the supply of loanable funds because of savings increasing, because of
a decrease in time preference, but it's an increase in investment demand because entrepreneurs
see an increase in profit opportunity.
So we think that's that.
And that just shows the same idea in terms of financial assets, I guess. This is a slightly
different one, and we do it first in figures 6a and 6b in terms of loanable funds, and
then in terms of 7, we do it in terms of financial assets, but I'll do it in terms of the one
I don't understand it because I think most people are probably aware of that, and that is that what happens, we always talk, and this is why I think it's important to focus on credit, not money, loanable funds or not.
If the supply of loanable funds, the supply of savings increases, we say well the interest rate goes down, and you know, if this is due to an increase in money, okay,
There's another possibility, and we see this in the real world, and that is that financial institutions don't necessarily lower interest rates.
Financial institutions are interested, among other things, in maintaining their net interest margin.
So it is not uncommon, and we saw this in the middle of the last decade in the housing market, that rather, I mean, yes, interest rates went down some, but then what did they do?
Remember, the demand curve for loanable funds, if we look at it in that term, is not determined strictly by the borrowers.
I, as the lender, can cause the demand curve for loanable funds to shift out. Why?
Severus Paribus. Demand curves show things, Severus Paribus. That demand curve for loanable
funds is an assumption that the risk profile of the borrowers is the same all along that
demand curve. Well, what happens if I, as the banker, decide I've got more funds to
I don't want to lend out. I don't want to lower the interest rate. I'll cut my net interest margin too much. You know what? Rather than cut my interest rate, I'm going to allow lousier borrowers, people with lower credit risk to borrow.
Well, that shifts out the demand for loanable funds. I think that's important substantively that we recognize that and look at the implications of that.
I think it's also something that we need to take a look at in our pedagogy.
I have some other things I could say, but you know, I think,
they're not directly relevant to, oh, well, I'll just, as long as I have a minute, can I make two points?
One of them is that we talk about the purpose of, you know, investments in saving and investment and all,
and all is that lowering the interest rate is to lengthen the structure of production.
If we understand that, that there's initial structure of production and there's a transition
phase and then there's an end stage, although that may be the case sometimes that we want
to lengthen the structure of production, the permanent one, in point of fact what we do
is we lengthen the structure of production temporarily, but the ultimate ideal end state
structure of production in terms of the Hayekian Triangle is a vertical line
where Barnett says I wish I had a Rolls Royce and boom there it is it's produced
right there the time period of production is reduced that we want the
time period we want that the value of consumption to go up but we want that
triangle to get steeper and flatter we have to go with that and my time is up
Thank you very much.