Multiple Own Rates of Interest – Does it matter in a Monetary Economy?
There has been a very good discussion over the last few months about the argument promoted by Sraffa (though first used by Fisher) that because each commodity will have its ‘own’ rate of interest it is not possible to assume a single ‘natural’ rate in the economy. This on its face not only undermines Austrian Business Cycle Theory but all work in the Wicksellian tradition including Woodfords brand of New Keynsianism which has been so influential to Central Bankers.
Here at Daniel Kuehn’s blog. Here (with many comments) on David Glasner’s blog. Here is an older comment on “Lord Keynes” blog. Bob Murphy also has a paper (pdf) and JP Koning has a contribution as does Daniel Kuehn.
An own rate is the difference in price of the same commodity between two points in time. But passage of time will change the commodity. Strawberry seeds will grown into strawberrys over several months and will rot to zero value over several days. At each point in time they will be different commodities. We therefore need to consider production and the money needed to put the commodity into production. This will require consideration of costs of storage & carry.
Lets consider an ‘own rate’ as a rent of money saved or created to bridge the inter temporal price gap between T0 – the input price- and T1 – the output price- when the produced commodity will be sold.
Lets then consider a toy model that for every commodity there is a bank solely financing that commodity.
A loan by a bank to finance the commodity purchase will be on the assumption of a sale price at T1. They will make more or less profit dependent upon the accuracy of their forecast.
Wheat yield at T1 will depend upon the risks of a bad harvest and will built into the price of credit.
If there is a bad harvest the equity of the bank will decline and their ability to lend for production of that commodity will fall. If there is a run of bad harvests the equity price of the bank will fall against risk adjusted assumptions.
An investor then – in a toy model where the only investment opportunities are single commodity banks, will attempt to form a portfolio of different banks to hedge risk over the yield period of their investments.
Now widen the model so that banks could not only loan against their single commodities but also to purchase other peoples bank investment portfolios. This will then produce a single ‘money market’ interest rate.
So can we say ‘so what’ for multiple own rates then? Can we say it doesn’t matter in a monetary economy?
No – because different commodities will have different responses to changes to the ‘money’ interest rate.
If interest rates are lowered then production will become profitable for processes with high own rates/high risk rates and vice versa. This creates the conditions for speculation and overinvestment in some sectors (which wont always have a lot to do with the time structure of capital – but this is a much more complex point)
If all own rates were identical then we have a speculation and arbitrage free economy – not the real world. But differential profits and own rates drives the dynamics of the economy.