Market Forces and Own Rates

A modest wordpress through its linkback facility can sometimes trigger vigorous internet discussions.  As my post yesterday on multiple own rates did which triggered discussion by David Grasner and then Nick Rowe, with follow up in the comments by Richard Murphy and JP Koning.

David said

Laiton (sic) apparently thinks that there could be multiple real own rates, but seems to me to overlook the market forces that tend to equalize own rates, market forces wonderfully described by Keynes in chapter 17.

No it is not market forces that ‘equalise’ own rates it is market forces which create own rates.  The point I was making that it is the money market not product markets which equalises interest rates was missed.

In the supermarket yesterday, the same physical product but two commodities.  Unripe mangos half the price of ripe ones.  It says on the packet keep them in your fridge for a few days to ripen.  Here we have a commodity with a very high own rate.

Market forces do not lead to the convergence of own rates between ripe and unripe mangos, rather it is the product market which always and everywhere leads to the divergence of own rates.

Market forces will erode differences in cost between a single  commodities but here we are talking about two different commodities with the same cost structure to the producer.

My post was triggered by the comment to the debate from Daniel Kuehn

So what accounts for the different observable own-rates on Chicago and Minneapolis wheat? First, you have to take into account storage. Sure, you may earn more holding Chicago wheat, but storage costs may be far higher in Chicago so that final returns are equalized. You also have to think about risk.

JP Konings comments

The above is really just a restatement of John Maynard Keynes’s Chapter 17 of the General Theory.

Chapter 17 of course was concerned with the equalization of the investment returns.  The quote from the chapter which sums it up is

the total return expected from the ownership of an asset over a period is equal to its yield minus its carrying cost plus its liquidity-premium, i.e. to q – c + l. That is to say, q – c + l is the own-rate of interest of any commodity, where q, c and l are measured in terms of itself as the standard.

Then he set out an investment schedule

As output increases, own-rates of interest decline to levels at which one asset after another falls below the standard of profitable production; — until, finally, one or more own-rates of interest remain at a level which is above that of the marginal efficiency of any asset whatever.

But there is an error here, either of clarity of exposition or theory, because at the profitability frontier what is being equalised is the rate of profit on investments not those aspects of return which are time variant.  Costs of carry and liquidity premiums (which are likely to be relatively time inelastic) may more than outweigh differential yields, the primary cause of differential own rates, as in our example above.  Keynes example is of an investor investing directly in one of many possible production processes and receiving all profits, not of an investor investing in one of many possible firms each with different rates of profit.

And let us underline we are talking about own rates in a monetary economy not in some hypothetical barter economy (where costs of carry and liquidity premiums would be way different).

Minky’s concept of dual markets is useful here.  In output prices differential yields create differential own rates however the asset price market through the money & equity market equalises rates of profit on those products.

4 thoughts on “Market Forces and Own Rates

  1. Andrew: your first quote is from David Glasner, not me. I disagree with David on that point. (Actually, I have just written a comment on David’s post saying I disagree with him on that point.)

    I fact, when you say “No it is not market forces that ‘equalise’ own rates it is market forces which create own rates. The point I was making that it is the money market not product markets which equalises interest rates was missed.”

    I fully agree with your first sentence. I would quibble with your second sentence, because I would say it’s both “money market” and product markets which equalise rates.

    (And I hate the words “money market” as a synonym for “loan market” or “bond market”, because the whole point about monetary exchange economies is that *every* market is a money market. But that’s just a bee in my bonnet.)

  2. Here is part of the comment I left on David’s blog, explaining why own rates differ:

    “I think about that bit very differently. The “own rate of interest on apples” is the nominal rate of interest minus the rate of inflation of apple prices. If apples cost $1 each this year, and I lend someone $100 (or $100 apples), and if the interest rate on money is 5% and the rate of inflation on apples is 2%, then next year I get back $105, which is worth (approx) 103 apples (or I get paid back 103 apples) so the own rate of interest on apples is 3%.

    Maybe apples can’t be stored, because they rot. And the borrower just eats the apples. Who knows. But if technological progress in growing apples is causing the price of apples to fall relative to the price of bananas, then if the apple inflation rate is 2% the banana inflation rate could be 4%, so the own rate on apples would be 3% while the own rate on bananas is 1%.”

    In other words, own rates differ across goods because relative prices change over time and are expected to change over time. For all sorts of reasons. It’s as simple as that.

    • I don’t think this is a particularly useful way at looking at the cause in change in prices.

      We can nominalise any price by indexing it relative to other products.

      But in looking at the change in price between T0 and T1 we need to know what proportion of the change in price is due to the change in the value of money or the change in the value of the product & its intermediate products.

      The change in the value of money will be the same for all products but if we are talking about the ‘own rate’ we are looking at what has uniquely caused the value shift in that product – a very Ricardian point perhaps unashademedly.

      This is important because the cost structure of products will be dependent on the debt burden of assets comprising their productive structure. That is to what extent revenues from real goods delivering a revenue yield are offset by payment of interest on assets.

      The higher interest rates are relative prices of high debt productive processes will rise in relative terms & will be starved of investment

      As interest rates fall relative prices of high debt productive processes will fall in relative prices and investment will grow.

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