Monday, February 19, 2007

Hayek Versus Sraffa

I think Piero Sraffa talks his friend Friedrich Hayek into an absurd position here:
"Mr. Sraffa denies that the possibility of a divergence between the equilibrium rate of interest and the actual rate is a peculiar characteristic of a money economy. And he thinks that 'if money did not exist, and loans were made in terms of all sorts of commodities, there would be a single rate which satisfies the conditions of equilibrium, but there might, at any moment, be as many "natural" rates of interest as there are commodities, though they would not be equilibrium rates.' I think it would be truer to say that, in this situation, there would be no single rate which, applied to all commodities, would satisfy the conditions of equilibrium rates, but there might, at any moment, be as many 'natural' rates of interest as there are commodities, all of which would be equilibrium rates; and which would all be the combined result of the factors affecting the present and future supply of the individual commodities, and of the factors usually regarded as determining the rate of interest. There can, for example, be very little doubt that the 'natural' rate of interest on a loan of strawberries from July to January will even be negative, while for loans of most other commodities over the same period it will be positive." -- F. A. Hayek (1932)

"I have only a few words to add on the second cardinal question, that of the 'money' and the 'natural' rates of interest. Dr. Hayek's ideal maxim for monetary policy, like that of Wicksell, was that banks should adopt the 'natural' rate as their 'money' rate for loans... I pointed out ... that when saving was in progress there would at any one moment be many 'natural' rates, possibly as many as there are commodities; so that it would be not merely difficult in practice, but altogether inconceivable, that the money rate should be equal to 'the' natural rate... Dr. Hayek now acknowledges the multiplicity of the 'natural' rates, but he has nothing more to say on this specific point than that they 'all would be equilibrium rates'. The only meaning (if it be a meaning) I can attach to this is that his maxim of policy now requires that the money rate should be equal to all these divergent natural rates."-- Piero Sraffa (1932b)
So what does this victory of Sraffa over Hayek amount to? It's very puzzling, and you won't find any help here. This defeat for Austrian business cycle theory puzzled contemporaries too:
"I wish [Hayek] or someone would try to tell me in a plain grammatical sentence what the controversy between Sraffa and Hayek is about. I haven't been able to find anyone on this side who has the least idea." - Frank Knight to Oscar Morgenstern (as quoted by Caldwell)
Update: Some additional quotations for commentators' amusement:
"The starting-point and the object of Dr. Hayek's inquiry is what he calls 'neutral money'; that is to say, a kind of money which leaves production and the relative price of goods, including the rate of interest, 'undisturbed', exactly as they would be if there were no money at all...

...But the reader soon realizes that Dr. Hayek completely forgets to deal with the task which he has set himself... Being entirely unaware that it may be doubted whether under a system of barter the decisions of individuals would have their full effects, once he has satisfied himself that a policy of constant money would achieve this result, he identifies it with 'neutral money'; and finally, feeling entitled to describe that policy as 'natural', he takes it for granted that it will be found desirable by every right-thinking person. So that 'neutral' money ... in the end becomes 'our maxim of policy'.

If Dr. Hayek had adhered to his original intention, he would have seen at once that the differences between a monetary and a non-monetary economy can only be found in those characteristics which are set forth at the beginning of every textbook on money. That is to say, that money is not only the medium of exchange, but also a store of value, and the standard in terms of which debts, and other legal obligations, habits, opinions, conventions, in short all kinds of relations between men, are more or less rigidly fixed. As a result, when the price of one or more of these commodities changes, these relations change in terms of such commodities; while if they had been fixed in commodities, in some specified way, they would have changed differently, or not at all..

It would be idle to rehearse these platitudes had not Dr. Hayek completely ignored them... The money which he contemplates is ... used purely and simply as a medium of exchange. There are no debts, no money-contracts, no wage-agreements, no sticky prices in his suppositions..." -- Piero Sraffa (1932a)
  • Hayek, F. A. (1932). "Money and Capital: A Reply", Economic Journal (reprinted in Hayek 1995), V. 42 (June): 237-249
  • Hayek, F. A. (1995). The Collected Works of F. A. Hayek: Volume 9: Contra Keynes and Cambridge: Essays, Correspondence (edited by Bruce Caldwell), University of Chicago Press
  • Sraffa, Piero (1932a). "Dr. Hayek on Money and Capital", Economic Journal (reprinted in Hayek 1995), V. 42 (March): 42-53.
  • Sraffa, Piero (1932b). "A Rejoinder", Economic Journal (reprinted in Hayek 1995), V. 42 (June): 249-251


Anonymous said...

From what i can gather, the Austrian position on the business cycle is that it is caused by banks loaning out more money than they have in savings (gold). In other words, that banks act like banks.

Saffra basically got Hayek to admit that capitalism would only be stable if there was no money and banks did not act like banks. Hayek's aim was to show that stability would arise when the interest rate was the "natural" rate, i.e. would produce a demand for loans which are identical to savings.

I'm not sure how relevant a theory of capitalism is which argues that everything would be fine if banks did not act like capitalists. Or if money did not exist.

I think that the Austrians have never got over the way Saffra, Kaldor and other Keynesians destroyed the arguments of their leading lights. In fact, they rarely mention Kaldor's destruction of his former mentor's theories.

You can tell by the bitterness of their hatred of Keynes. Which is quite ironic, as if they had followed Austrian ideas in the 1930s then private capitalism would not have survived.


Michael Greinecker said...

While, I don#t know how money relates to that, Hayek is right that there can be equilibria where different commodities have different interest rates and that all equilibria may be of that kind.

One cannot delegate all intertemporal prices to one market.

It seems to me that Hayek and Sraffa agree here.

Anonymous said...

I'm not an expert in economics but here is what I think the argument means. I have to try and think of the examples in things I understand more than the theoritical.

Let's take houses, one of many commodities and one that's subject to business cycles of housing booms and busts. Interest rates for home loans are based indirectly on what the govt sets for it's prime rate of lending money to banks who then lend to home buyers. The business cycle of homes are booms where there is an increase in home buying and home prices follow with the opposite being busts with decreasing home sales and lowering home prices. If the govt keeps the interest rate low then more people can buy homes and home prices go up causing inflation and the opposite is true if interest rates go too high. So if the govt keeps playing with interest rates that affect home prices then you get booms and busts of housing prices. So Hayek's argument is that if you want to prevent housing booms and busts banks should really set one constant rate for home loans that tries and balances things out instead of it floating on a govt rate.

Because all rates get more or less based on the govt rate plus their cut banks are going to loan out to business at the same rate but each industry is going to have a different profit margin so a 5% rate might cause a housing boom but it might be too high for farming industry causing a farming bust.

Anonymous said...

Except, of course, that if there are multiple equilibria for an economy for numerous goods, then the idea that there can be one interest rate for money becomes meaningless. As such, a theory of the business cycle which is based on their being a natural rate of interest is flawed as there can be no such rate. This is ignoring the issue of whether banks can be forced not to act like banks, of course.

Saffra's critique was then used by Keynes in the General Theory to refute claims that there is one ("natural") rate of interest.

Overall, I would say that Saffra's basic point is that Austrian business cycle theory is not applicable to any advanced capitalist economy (i.e. one with banks and money). The notion of a "natural" rate of interest becomes meaningless in a multi-good world and the notion that all we need to do is get banks to stop fractional reverse banking and everything will be fine is, to say the least, inapplicable in the real world.

Money is the key to the whole thing as the Austrian theory is based on the abolition of banking and the enforcing of commodity money. As Saffra showed, the latter implies multiple "natural" rates and it is unlikely that any real interest rate will reflect this.


Michael Greinecker said...

"Except, of course, that if there are multiple equilibria for an economy for numerous goods, then the idea that there can be one interest rate for money becomes meaningless."

The problem is not multiple equilibria but different interest rates in the good market.

Suppose there are two periods and two commodities, apples and oranges. All people have a endowment of the two goods in period 1 and none in Period 2. They can hower plant them instead of consuming them. Planting 1 apple now gives 2 apples tomorrow. Planting 1 orange now gives three oranges tomorrow. Since interest rates are basically intertemporal prices, we get two different interest rates in equilibrium.

Michael Greinecker said...

Come to think of it, pretty much any money interest rate is compatible with equilibrium. You just have to make the prices in the second period high enough.

Robert Vienneau said...

Thanks for all the comments.

Iain, I agree that Sraffa had the better of the argument with Hayek. Kaldor’s early papers are more complicated. I think they might have been clearer if the tradition was to use a bit more mathematics at that time. Hayek’s writings on business cycles, capital theory, monetary economics, the Ricardo effect, etc. are less than a model of clarity too.

Be that as it may, Hayek had every opportunity at the LSE to put his case. And you’re right that so many of his potential followers slipped away, finding Keynes’ ideas more attractive.

Michael, I agree that the narrow issue here is rates of interest simultaneously varying across commodities, not one of multiple equilibria. But Iain does have a point that Hayek was arguing that without banks acting like banks, everything would be OK. This seems like a poor argument to me.

And I agree that both Hayek and Sraffa agreed that intertemporal changes can affect more prices than just the interest rate. They disagree on whether such a divergence of own interest rates can be called an “equilibrium”. I’ll punt for now on what issues of substance are involved here. (I’m also not going to try to formulate a coherent response to your own blog post about handicaps.) But I will note that in Hayek’s Prices and Production, the book under review by Sraffa, Hayek is quite clear in the first chapter that he is drawing his triangles for stationary states, in which no such divergence can arise.

And I’ll note a number of history of thought issues. Sraffians, like Garegnani, have emphasized Hayek’s role in changing the notion of equilibrium to include an intertemporal equilibrium. You can find Hicks acknowledging Hayek’s influence in his Value and Capital, where the concept of a sequence of temporary equilibria are put forward.

Iain is correct that Keynes built on Sraffa’s concept of own rates of interest. This is in Chapter 17 of the General Theory. And a common reading of Keynes is that he argues there isn’t one unique equilibrium.

Anonymous, the issue is not solely banks varying the rate of interest. According to Hayek, in the Wicksellian tradition, the natural rate can vary because of productivity shocks. In such a case, the central bank would have to vary the interest rate to track movements in the natural rate, if it were to follow Hayek’s pre-Sraffa policy precept. As Sraffa points out, since Hayek rejects the use of aggregates and prices indices, he cannot coherently call for the central bank to track some average of these divergent rates.

Michael Greinecker said...

"Michael, I agree that the narrow issue here is rates of interest simultaneously varying across commodities, not one of multiple equilibria. But Iain does have a point that Hayek was arguing that without banks acting like banks, everything would be OK. This seems like a poor argument to me.

That is true, but the probles is IMO that Hayek uses a non-monetary model with efficient equilibria to argue everything would be well on the free market- without money!

Anonymous said...

«That is true, but the probles is IMO that Hayek uses a non-monetary model with efficient equilibria to argue everything would be well on the free market- without money!»

But that is precisely where ''sycophantic'' economics falls: that money is considered to be a veil, and the markets to be free, and so on.

The usual ridiculous simplifications that are basically designed like Debreu and rational expectations to wish away the problem of value and capital, that is, the big dirty issue, income distribution.

My take is that Sraffa managed to just draw in Hayek and and get him to expose his approach as being same old same old.

Same old that gets you tenured jobs at major economics departments :-).

Robert Vienneau said...

I think, Michael and blissex, you will enjoy seeing the Sraffa quotation I have added. I think it generally supports your views.