Saturday, July 9, 2011

Bob Murphy's Move to the Dark Side

Bob Murphy must be angling for a position at Princeton or at the Fed. He informs us at his blog that he thinks:

Keynes is brilliant in Chapter 13 of the General Theory...on his neutral, scientific assessment of what interest is, I actually agree with him more than Mises.
What words of wisdom did Keynes spew in Chapter 13 for Murphy to run into the arms of Keynes? Murphy quotes the following:
It should be obvious that the rate of interest cannot be a return to saving or waiting as such. For if a man hoards his savings in cash, he earns no interest, though he saves just as much as before. On the contrary, the mere definition of the rate of interest tells us in so many words that the rate of interest is the reward for parting with liquidity for a specified period. For the rate of interest is, in itself, nothing more than the inverse proportion between a sum of money and what can be obtained for parting with control over the money in exchange for a debt for a stated period of time.
Say what? Maybe Murphy sees something different in the obtuse writing style and sloppy terminology that Keynes uses in the other chapters of  The General Theory, but I don't. To me it is more of the same distortions and odd definitions. Let's take a look at his use of the word "savings" in the above paragraph.

You can essentially do three things with money. 1. You can hold onto it as cash. 2. You can spend it on a consumption good or can loan it out and expect a return on your money.

Keynes uses "savings" to mean BOTH 1 and 3, simulataneously. It is this cross-definition that causes typical Keynesian confusion. He writes:
It should be obvious that the rate of interest cannot be a return to saving or waiting as such. For if a man hoards his savings in cash, he earns no interest, though he saves just as much as before.
Let's take out the word savings in Keynes sentence and replace them with synonyms and you will see the problem with Keynes mis-use of the word savings (replaced words in italics):
It should be obvious that the rate of interest cannot be a return on the two different senses in which I use saving. For if a man holds cash, he earns no interest, though he has not spent the money on a consumer good just as much as before.
Well, blow me down. If you use a word in two different senses, you are going to get real confusion.

Let's continue. Keynes introduces the word, "liquidity", which he states is the "reward" for not holding cash as a cash balances, but lending it out.

..the mere definition of the rate of interest tells us in so many words that the rate of interest is the reward for parting with liquidity for a specified period.

Austrian economists (including Mises) would call this "parting with liquidity for a specific time period"
, a demonstration of time preference. Keynes is simply using different terminology for the same concept. (Note: Keynes uses the term "liquidity" in different senses through out The General Theory, so I am only discussing the manner he uses it in this paragraph). Austrians would also use the word "cash balance" for what Keynes calls liquidity here. When all is said and done, what Keynes is just saying here is that interest IS a payment for time preference. Give up the use of your money temporarily and you will get paid for it. Which contradicts the first part of his paragraph where he writes:
It should be obvious that the rate of interest cannot be a return to saving or waiting as such.
Keynes confuses things here because he is using the word savings, as described above, simultaneously in two different senses . You don't get paid for holding cash (which Keynes calls savings). You do get paid for loaning out your money (which Keynes also calls savings). Because he uses the term in these two different senses, he reaches the conclusion that you don't get paid for savings. He then circles around to say you get paid interest for "liquidity" by which he means for extending out your time preference, i.e. tfor saving your money. In short, by Keynes use of the term savings to mean two different things, he reaches the absurd conclusion that you don't get paid interest for savings. He then doubles-back and introduces "liquidity" as the reason interest is paid, which is the Austrian sense of time preference and why you are paid interest in the first place.

Keynes than goes on to state in typical convoluted fashion that:
For the rate of interest is, in itself, nothing more than the inverse proportion between a sum of money and what can be obtained for parting with control over the money in exchange for a debt for a stated period of time
Which is to say that the interest rate is the ratio between payment received above principle divided by the principle, for lending out of money. Duh.

Bottom line, by stepping away from the way the term savings is normally thought of (You don't think that the money in you wallet is part of your savings, but you do think your bank CD is part of your savings) and the way it is used by other economists, Keynes creates mass confusion and little else.

This Keynes confusion, simultaneous multi-use of a term in two different ways and typical obfuscating manner of discussion is what causes Murphy to write:
...on his neutral, scientific assessment of what interest is, I actually agree with him more than Mises.
Yikes. How does  it feel over there on the dark side, Bob?


  1. You know you've done something wrong when someone like Daniel Kuehn is the first in the comments to cheer you on.

    By the way, nobody understands the English language, least of all the English.

    When I use a word, it means just what I choose it to mean — neither more nor less.
    -John "Humpty" Keynes

  2. Hello Bob. I greatly enjoy your work. In this case, isn't Keynes simply using "savings" interchangeably with "hoarding?" Then everything would appear to make sense.

  3. Maybe Bob had indulged a bit too heavily and opened the General Theory at random and suddenly, it making sense, drunk posted about it.

  4. Bob is short for Robert, no? So this comes from the adjunct scholar for the Mises Institute AND he teaches there. I would love to read Lew Rockwell's opinion.

  5. What can you expect of a people who say:

    "There are less cans of tomato soup.", when the proper LOGICAL version is:
    "There are FEWER cans of tomato soup."
    Uh, oh "Too much aggregation"! So THAT'S where that started...

  6. Wow, thank you for laying it out so well Robert. For the past one or two days, I read Murphy's post(though not his PHD dissertation admittedly) and tried to think about it. At the end I came to the conclusion that liquidity preference and time preference were directly related, so I still held on to the same conclusion that Mises and Rothbard held. Thank you for laying it out in a more intelligent and straight forward manner than I could.

  7. I sure hope that Bob isn't coming down with the Callahan syndrome. That would be a shame.

  8. Thanks for helping us try to 'decode' Keynes. It's remarkable how much sloppy thinking has become the basis for revered policy. Could Bob Murphy himself have been bamboozled like most everyone else?

  9. I asked the good doctor to comment on Hazlitt's view of the material that he (Murphy) found to be so brilliant. I am not saying that Murphy is wrong and Hazlitt is right, or vice versa, but since I respect them both, I would like Dr. Murphy to compare his views with those of Hazlitt so that we could then think and ponder and make up our own minds. Unfortunately, I cannot ask the same of Henry Hazlitt. Dr. Murphy hasn't responded to my question yet, I know he is a very busy man...(The view's of Hazlitt of which I speak are from, "The Failure of the New Economics.")

  10. This is one of the reasons I LOVE EPJ! Although the argument is somewhat esoteric, it forces the reader to think deeply about our beliefs about fundamental issues.

    I'm still pondering what Murphy- one of the best Austrian economists in the biz- really means with this line of thinking.

    That's also one of the best parts of studying a "fringe" economic theory like Austrianism. Even if we disagree, sometimes vehemently, with the position of another economist, we still show a level of civility and open-mindedness that is alien on other "Econ" bloggers ( I use quotes because most of the other Econ blogs aren't discussing economics, simply trying to cover their failures)

    However, having re-read this post 287 times over the last few hours, I can see Murphy's point. Just like the Bitcoin situation, it is going to take a lot of deep thought to untangle this rather strange knot!

  11. re: "Bottom line, by stepping away from the way the term savings is normally thought of (You don't think that the money in you wallet is part of your savings, but you do think your bank CD is part of your savings) and the way it is used by other economists, Keynes creates mass confusion and little else."

    You seem to be confusing "liquidity" with "cash in your wallet". Liquidity for Keynes is simply the control over funds to use as a medium of exchange.

    You can save $1,000 in your mattress for ten years, you can save $1,000 in a savings account for ten years, you can save $1,000 in a 2 year CD for ten years (rolling it over four times), you can save $1,000 in a 5 year CD for ten years (rolling it over once), or you can save $1,000 in a 10 year CD for ten years.

    In each case your time preference is to forgo $1,000 in the present and use it ten years from now. However, your liquidity preference varies in each case.

    Holding time preference constant, we still have a variance in the interest rate that people are willing to accept.

    That's the liquidity preference theory of interest. That's all it is. It shouldn't be all that controversial. People should be able to identify this in their own lives - think about how much you keep in a savings account vs. how much you tie up in other accounts. Usually it's not because the amount you keep in savings is expected to be used any more imminently than what you keep in a CD or something else. Sometimes people have a specific imminent purchase in mind, but often it's intended to sit and earn interest for the same amount of time. You just trade off the interest rate against how accessible you want those funds. If you need less accessibility you tie it up in a higher interest rate account for the exact same time span that you're expecting to leave the money in savings. It's precisely the uncertainty of those expectations that causes us to keep money liquid. If we were certain, we'd put it all in a high interest account for precisely the time period that is consistent with our time preference.

  12. Putting aside the problems that Wenzel lucidly points out in his post, Murphy's greater point is that interest is determined by the liquidity preference of money itself.

    Liquidity preference could interchangeably be called "time" preference, but perhaps the former includes a layman's connotation of sacrifice of present funds not just for greater future funds, but also concerns of risk and loss of control over ones funds. But this is word mincing at this point.

    However, Bob Murphy is saying that the great Austrians typically referred to a natural time preference involving all present/future goods in an economy, not just money which Murphy advocates as the determinant of interest. At this point I think Mr. Muprhy is correct, as it treats money as its own commodity, and thus may be more "Austrian" than even some of the great Austrians themselves.

    But I think it is best understood as a refinement rather than replacement of existing theory, because one's "liquidity preference" for money today is in my view based on (1) the desire to consume any present goods versus a future good (traditional Austrian time-preference theory, and (2) the desire to have the option of doing #1, but keep other uses of the funds open. As to point #2, just using a real-world example, one may hold cash balances because of regime uncertainty and the desire to be able to liquidate quickly if the SHTF. Or because one may want to easily purchase consumer goods b/c interest rates are so low.

    The traditional Austrian theory perhaps then was too imprecise and lacked the refinement of "control" over cash itself as being part of the determinant of interest rates, but it nonetheless explains in a broader conceptual sense the reasons for the interest rate which Keynes to my knowledge does not cross beyond his confusing paragraph that Wenzel dissects.

  13. I was going to make a Darth Vader joke, but this is actually an important issue and I'm amused at how many people are high-fiving Wenzel here, when he is the one who is clearly using a weird, non-layman's definition of "saving."

    15-year-old Johnny mows my lawn every week, and I pay him $20 each time. Every week, he spends $15 of it going to the movies with his friends, but he puts $5 in a piggy jar on his bureau.

    After a year, he has accumulated $5x52 = $260 which he uses to buy a nice watch. Johnny says, "I'm sure glad I consumed less than my income all year, saving $5 per week. Then I used my accumulated savings to buy a watch. I deferred consumption all year in order to buy a nice good later on."

    Wenzel says, "What the heck are you talking about? Are you a Keynesian Johnny? You haven't saved at all."

    Are you guys all comfortable with that? You don't think Johnny was saving $5 per week?

  14. @Bob Murphy

    So Keynes was talking about kids piggy banks and Groupon discounts? Now it all make sense to me.

  15. Not only is Keynes confused about the definition of savings, he is also confused about the definition of interest. Which interest rate was he talking about, the market rate or original interest?

    Interest would exist in a barter economy. No one would his team of oxen to his brother-in-law for a year and expect no compensation at all. He would at least demand that his brother-in-law stay leave him alone for a couple of years.

    Original interest is closely tied to opportunity cost and that's how Mises thought of it, though he expressed it in different terms.

    If someone hoards their savings and doesn't loan it out, he incurs no opportunity costs, so there is no interest.

    To suggest, as Keynes did, that anyone in history ever believed differently is just dishonest or ignorant or both. Then Keynes commonly lied about what other people believed in order to easily defeat their arguments.

    But that's all about original interest, which has little to do with market interest rates. Market rates have to do with risk and money supply.

    I suspect Keynes knew what he was doing when he deceitfully switched between definitions of interest and savings. He was an incredibly dishonest person.

  16. PS, Keynes is also dishonest in his use of waiting. No one in history ever suggested that mere waiting was sufficient to cause interest. Godot waiting for God never earned any interest for his waiting and no one ever has expected that he would.

    The "waiting" that Mises and every other good economist referred to was waiting to get your investment back. It was a very specific type of waiting and had nothing to do with Keynes dishonest use of the term.

    Again, the waiting that generates interest is the opportunity cost of giving up your wealth for a period of time, whether that wealth is money or potatoes.

  17. I messed up the Godot reference. Sorry. Typing faster than I could think. It should say Vladimir and Estragon earned no interest waiting for Godot.

  18. If I am absolutely sure that I will need this 1000$ in 10 years, and not a day earlier, then I will chose the form of investment with the highest return (if risk is equal everywhere).

    The more I am insecure about this 10 years (because what if my car breaks down, and I need this money for a new car), the higher my time preference and I will chose a more liquid form of saving. So couldn't I argue that the more uncertain I am about my future, the more liquid the asset has to be, hence the higher is my time preference?

  19. I like Bob Murphy's definition of interest: the rate of interest is an exchange rate between present and future dollars.

    I would add the following, though:

    the rate of interest is an exchange rate between present and future dollars that are available to the market.

    I agree with Robert Wenzel completely on his point that savings in a couch are different than savings in a CD.

    You see, if I have a CD with a bank, the dollars in that CD are available to the market. If I instead stuff those dollars into my couch, they are no longer available to the market.

    If I grow apples and put my entire crop onto the market, the price will be different than if I left half of the crop in my large basement away from the market.

    The Keynes paragraph is just one component (liquidity preference) that will affect the rate of interest. It's funny how Keynes was a mathematician originally, yet he always tried to explain every economic phenomenon as being a function of a single variable. He must have been a lousy mathematician, too, which would explain the career change.

  20. I may be off base here, but it seems to me that a lot of thought of interest rates here is subconsciously affected by the central bank. In other words, it feels like everyone is taking only the view of the saver and forgetting about the role of the borrower -- giving this discussion the feel of Fed-style "pre-ordained" interest.

    From the borrower's perspective, sans Fed, you would seek to borrow based upon your belief that you can turn the borrowed money into a future profitable enterprise of some sort such that you ultimately make more than you have to pay in interest. However, the lenders have to take into account not only the time preference of the money they're lending, but the risk involved that they won't receive some or all of the money they've lent out.

    There is, however, also risk in holding money as cash. You can lose it, forget where you put it, or it can be stolen. So, Johnny with his piggy bank has to decide whether he keeps his money in a piggy bank, leaving it potentially exposed to his heroin-addicted sister, lend it to his uncle for 100% return on investment in two days after Uncle takes it to the track, or place it into a bank where the perception of safety is higher, but the return is more modest. You could potentially insure your cash against theft or loss, or even come up with other schemes to protect it. All of these schemes would cost money or time leading to an effective negative interest rate for "hoarding" cash.

    I guess the summation of my thought here is that interest is not just a function of the lender, but also of the demand set by the borrower. I know that's obvious, but I wasn't getting that sense overall from the discussion. Also, the costs for the lender are not just time preference, but risk preference as well, and there is risk in "hoarding" money as cash (which potentially increase as the demand for money grows).

  21. I am the same anonymous that wrote the July 26, 2011 1:26 AM comment above. Dr. Murphy did give me a thoughtful reply to my post on his blog site. On his blog site I am senyoreconomist. His reply was just what I was looking for. I thank him very much for that.

  22. Daniel Kuehn:

    In each case, your time preference WHEN YOU MAKE THE DECISION to hoard or invest for a longer or shorter time period, are not the same. They are DIFFERENT. Investing at time zero in a 2 year CD is deferring consumption for less time than investing in a 5 year CD.

    Interest rates are actually created (decided) the moment in time the decisions are made. You are NOT making the decision to roll-over any investment at time zero.

    If you did in fact decide today to invest in a "2 year CD rolled over once", you'd actually be investing in a 4 year CD, not any 2 year CDs.

    If you invested in a 2, 5 or 10 year CD, and you EXPECT to decide again in the future to roll it over, then you haven't actually made any decision to invest today for those future roll-overs. Your decision is to invest in a 2, 5, or 10 year CD. Interest rates are set when decisions to borrow and lend are made. They may be influenced by future expectations, but you cannot observe interest rates on 2, 5 or 10 year CDs 2, 5 or 10 years from now. Interest rates are observable rates for actual investments, for actual lending and borrowing.

    If you hold $1000 as cash, you are making the decision to have an instantaneous ability to consume, which is why such a decision carries a 0% interest rate. For a 2 year CD, you are abstaining from consuming for at least 2 years AT THE TIME YOU MAKE THE DECISION to abstain from consumption.

    The liquidity preference doctrine can easily be seen to not have ANYTHING to do with interest rates at all, by simply considering conditions of very rapid inflation, where the desire to hold money collapses to virtually zero, and interest rates, instead of approaching zero as the liquidity preference predicts, instead approaches very high levels. Similarly, the lower the rate of inflation, the higher the demand for money tends to be, and interest rates become lower, not higher as the liquidity preference predicts.

    Liquidity preference just isn't a determinant of interest rates. What you believe is liquidity preference is actually time preference.

    Savings in the form of money and savings in the form of CDs do in fact differ in terms of when one has the ability to consume. With holding money, your ability to consume is not deferred at all. You can consume right now. With the CDs, your ability to consume is deferred.

    You can ONLY "keep money" liquid. You can't "keep money" if you invest in a CD. A CD is not money. With a CD you are deferring your ability to consume. With cash, you are not.

    EVEN IF we had perfect future foresight, we'd still prefer present goods over future goods, and thus there would still be interest rates. Individuals would NOT borrow and lend at higher or lower interest rates unless they had different time preferences. Holding perfect foresight constant, interest rates will differ depending on people's time preference, not liquidity preference.

  23. Bob Murphy:

    Yes, Johnny is actually delaying his consumption each week in the amount of $5. So his actions will affect market interest rates. They will do so by affecting the market rates of profit. The way his actions will affect interest rates is by setting into motion a change in the economy's aggregate rate of profit. It is NOT because his "liquidity preference" has increased.

    We know that Johnny earns $20 each week. Out of that $20, he can consume, add to his cash, or invest. You say his decisions are that he consumes $15, and he adds $5 to his cash. His actions therefore generate $15 in revenues (in the consumer goods industry), and zero dollars as costs (since he is not making any investments he does not deduct any money expenditures from as costs).

    Since your example is an equilibrium example that masks the market process, where interest rates are actually created, we have to imagine how his actions affect the market interest rates by creating two different scenarios, where one scenario is dropped and then the other scenario is adopted. Thus, suppose the first scenario is that he consumes out of the full $20 each week, and the second scenario is that he starts to consume less each week, say $15, and he adds $5 to his cash balance.

    Initially, since he consumed $20 each week, his actions generated $20 in revenues (for consumer goods companies). His actions do not create any costs because he is not making any investments. He is therefore adding $20 in aggregate market profit (ignore CGS deducted by the consumer goods companies as sales are made for simplicity. We won't lose generality.)

    If we move from the first scenario to the second scenario, Johnny would consume less. How does that affect the economy? He is now generating fewer revenues (for consumer goods companies), though he is still making the same quantity of investment, i.e. no investments, and thus he is not deducting any costs, the same as before.

    Since consumer goods companies are now earning less revenues, they earn less profits. Here we can use Menger's capital structure of the economy insight to conclude that consumer goods industries will start to earn RELATIVELY less profits compared to the higher stage capital goods industries.

    That will in turn change the structure of the economy from more consumer oriented to more capital intensive oriented.

    In terms of money spending, relatively less spending will take place in the consumer goods industry, and relatively more spending will take place in capital goods industries. This occurs because investors invest more in relatively more profitable ventures and invest less in relatively less profitable ventures, all else equal.

    As relatively less spending takes place in consumer goods (because of Johnny's actions), and relatively more spending takes place in capital goods (because of the response from investors on account of Johnny's actions), this will decrease the spread between aggregate spending and aggregate costs. Thus, market rates of profit will decrease, and because market rates of profit decrease, (what Mises called originary interest, but in money terms) so will market interest rates decrease.

    Johnny doesn't earn any interest because he is not a capitalist. He just changed his consumption pattern over time, and that lead to investors and capitalists changing their investment decisions, and THAT is where the changes in interest rates come into being.

    According to Keynes however, since Johnny's "liquidity preference" has increased, then interest rates should have increased. But they did not increase. They decreased.

    What would happen if Johnny lived in an economy with very rapid inflation, and he, like most people, sought to get rid of their money as fast as possible, such that their demand for money approaches zero? Would interest collapse to zero or will they rapidly rise? Keynes says they should collapse to zero, but in reality interest rates would approach very high levels.

  24. I just don't buy the liquidity preference theory of interest. In my personal view of things, I would invest only money that I have determined that I do not need to be in a liquid state. People invest their last dollars, not their first. So given that I have already demonstrated a preference for funds to not be liquid in the first place, why would anyone compensate me for something I don't want in the first place?

    I just looked at CD rates at a random web site, and saw 1 year for 1.26%, 2 years for 1.00%, and 5 years for 1.90%. If it was all about liquidity preference, than the 2 year rate should be higher than 1 year, but it is not. Similarly, the rate for a home equity loan from my credit union spans from 6.125% for 5 years to 6.500% for 20 years. If liquidity preference is a factor at all, it could at most influence a .375% change in the rate for a loan with a term 4 times longer - only about 6% of the final rate. The overall rate of interest must be controlled by a far more powerful factor

  25. Bob Murphy wrote: "'I'm amused at how many people are high-fiving Wenzel here"

    As it became clear to me as soon as I made any comments that were "off the plantation," that is because they don't care at all about understanding the issue. They care about "their" side crushing the "other" side.


  26. "I agree with Robert Wenzel completely on his point that savings in a couch are different than savings in a CD."

    Uh, yeah, as would Murphy and Keynes!

  27. Prof Wenzel,

    I know we had our differences on whether or not tax credits are subsidies but here I am in full agreement with you.

    One of the best refutations of Keynes' General Theory comes from Hoppe's essay The Misean Case Against Keynes (available at

    On the Keynesian concept of interest, Hoppe writes:

    That this is false becomes obvious as soon as one asks the question, "What, then, about prices?" The quantity of beer, for instance, that can be bought for a definite sum of money is obviously no less a reward for parting with liquidity than is the interest rate, thus making the demand for money an unwillingness to buy beer as much as an unwillingness to lend or invest (see Hazlitt [1959] 1973: 188ff.). Or, formulated in general terms, the demand for money is the unwillingness to buy or rent nonmoney, including interest-bearing assets (i.e., land, labor, and/or capital goods, or future goods) and noninterest-bearing assets (i.e., consumer or present goods). Yet to recognize this is to recognize that the demand for money has nothing to do with either investment or consumption, nor with the ratio of investment-to-consumption expenditures, nor with the spread between input and output prices, this is, the discount of higher-order, or future, goods versus lower-order, or presend goods. Increases or decreases in the demand for money, other things being equal, lower or raise the overall level of money prices, but real consumption and investment as well as the real consumption/investment proportion remain unaffected: and, such being the case, employment and social income remain unchanged as well. The demand for money determines the spending/cash balance proportion. The investment/consumption proportion, pace Keynes, is an entirely different and unrelated matter. It is solely determined by time preference (see Rothbard 1983a: 40-41; Mises [1949] 1966:256).