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That "paper" is just kind of sad really. And he ain't much nicer to Mises, referring to his early work on socialism as "polemics" (presumably as opposed to the "science" of Lange et. al.?).

Reading that paper is like watching Chris Chelios play hockey right now. It's time to hang 'em up and go out gracefully rather than continue to look like you're a step or two behind the rest of the world.

Samuelson is just silly. If it is considered a "black hole" to have demonstrated better than your peers the failure of the Keynesian consensus in theory and practice, and to demonstrate in theory and pracitce the failure of socialism of all varieties. Moreover, it must be a black hole if you identify the methodological biases that led economist astray.

Samuelson once remarked that he feared for his discipline when reading the methodological statements of Knight and Mises. That about sums up all his problems. He was confused on almost every level of economic research.

Obviously he had a huge influence professionally and educationally. But that influence is dreadful, not enlightening. And his intellectual attitude and example of scholarly demeanor should be exposed to all in this article for its swallow nature.

Samuelson once remarked that we economnist work for the only prize worthy, the applause of our peers. But it isn't much of a prize when your peers in effect become collectively deluded by false ideologies (socialism and statism) and false methodologies (formalism and positivism) and when both our linked together (by the fatal conceit) it takes a bold and unpopular thinker such as Hayek (or Mises, or even later Buchanan) to right the intellectual ship. It isn't surprising then when those who are deluded by the fatal conceit fail to understand how their conceit was exposed by Hayek, and why it was so fatal.

I have just recently started reading Hayek's Prices and Production and I'm curious what Samuelson meant by "its mumbo-jumbo about the period of production grossly misdiagnosed the macroeconomics of the 1927–1931(and the 1931–2007) historical scene".

I recall in the 1980s Samuelson reduced himself to doing radio commercials for U-Haul (or maybe Rider).

==="Hayek as an economist fell into what physicists call a black hole"===

Wow that guy needs to make sure we know how smart he is. Like "black hole" is jargon at this point.

OK I'm gonna shut down what computer scientists call my laptop at this point and take a nap.

Could someone clear this up for me? Is this the same guy (Paul Samuelson) who writes for the Washington Post?

Whoever the Post guy is, usually writes good columns. But then I read econ blogs / papers and hear about some crazed guy by the same name.


Non-Austrians generally reject Austrian capital theory as incoherent. I think it's important to realize that such criticisms are for real. Indeed, it's one of my crotchets that we Austrians haven't really dealt adequately with the problem.

On the one hand we want to have a time structure of production in order to have our theory of the trade cycle. On the other hand we often cop out by describing it as purely subjective; the time structure of production describes something about the plans of entrepreneurs and in this sense varies from entrepreneur to entrepreneur. But we can't have it both ways. If it supports ATBC, then it's an "objective" notion. If it is a "subjective" notion, the ATBC cannot be sustained. I wish we would pick up on a suggestion by Peter Lewin and cut the Gordonian knot with the idea of "duration." Before we can do that, however, we have to see the problem and it's my impression that almost no Austrians see the problem.

I'm not denying BTW that Samuelson's paper doesn't do justice to Hayek.

What a crushing put down that people in the staff room at Harvard and MIT didn't know Hayek's name! Maybe Hayek should have hung out at Cheers (where everybody knows your name). Did they know that Stanley Wong had trashed Samuelson's early work? Did they know the difference between the state of the Soviet economy and Samuelson's description of it?

The ignorance, arrogance, provincialism and complacency of the piece reminds one of the mythical British newspaper headline that read "Fog in Channel, Continent isolated".

Considering the paper is written by a mainstream economist, I believe it´s great! Probably much more flattering to Hayek than anything, say, Krugman would write. Note that Samuelson acknowledges the fact that Hayek won the socialist calculation debate! Samuelson´s problem with P&P seems to be rather that it lacks a theory of depression, which I believe is debatable. Whatever the truth about Hayek´s capital theory, Samuelson is correct in pointing out that it has had little or no influence within economics.
No, seriously, coming from a person like Samuelson, it could have been much worse...

I just skimmed Philip Mirowski's book, _More Heat Than Light: Economics as Social Physics, Physics as Nature's Economics_, chap. 7, "The Ironies of Physics Envy" (on the web). It's awesome.

He pulverises Samuelson's pretentious pseudo physics.
PAS was a much of a fraud as an economist as Bernie Madoff was as a fiduciary and investor.

If anyone catches the "American aggregate production function" walking along the street, please arrest it for impersonating an economic theory, and alert Mr. Samuelson to put up its bail money.

And I'll repeat what I said at marginal revolution. If PAS can make the case for capital reswitching before the board of a company without being laughed out of the conference room after five minutes ("sorry, you're wasting our time, we've got a business to run"), I'll pay him $100.
With or without the 100%, 75%, and 50% interest rates he used in an example (did he have Zimbabwe in mind?).


I haven't read Samuelon's piece yet, but one thing for sure is that mainstream economists think that the "reswitching" controversy spelled the doom of Austrian capital theory. I discuss the issue here:

Roger, is that what you are talking about? I agree with Samuelson that Sraffa beat Hayek (at least on one major point) in their journal debate. Specifically, Sraffa was pointing out that outside of what Mises would call the evenly rotating economy, there was no such thing as "the" natural rate of interest. And Hayek didn't get what he was saying. So I could see how mainstream economists would have thought Sraffa won, especially the part where they're arguing about the General Theory and Keynes put in an editorial note saying Sraffa was right and Hayek was wrong. Ouch.

Hi Bob,

No. I was on about "objective" and "subjective." Is the order of a good (or the average period of production, or . . . ) "objective" or "subjective"? If it's "subjective," then why is it a problem if low interest rates lengthen the structure of production? If it is "objective," then how do you handle the fact that iron and coal are used to make iron and coal. It's a net, not a chain. I think the standard take among Austrians is that the order of a good is subjective. But then we have to give up ATBC.

Hayek himself said, in effect, that his book on capital was a mess.

hm.. I didn't know Keynes' treatise on money was considered to have been hostile to climatology.

Roger Koppl said:
On the other hand we often cop out by describing it as purely subjective; the time structure of production describes something about the plans of entrepreneurs and in this sense varies from entrepreneur to entrepreneur. But we can't have it both ways. If it supports ATBC, then it's an "objective" notion. If it is a "subjective" notion, the ATBC cannot be sustained.

Roger, can you explain why the ABCT doesn't work if the time structure of production is subjective, or give the name of some paper that explains that? I always thought that the ABCT is based on a time structure of production that is essencialy subjective but these subjective perceptions of the entrepreneurs have systematic tendencies towards some end state, with is "objective". The ABCT is based on a combination of tendency towards some objective with subjective"real states" of the structure of production.

Credit expansion distorts the subjective perceptions of the structure of production, but it tends towards of the same equilibrium. The crisis is the moment when the subjective perceptions of the entrepreneurs distorted by the credit expansion are set straight into the direction of the objective equilibrium structure of production. If you assume that the time structure of production is subjective them there is no way for credit expansion to generate malinvestment because there is no malinvestment in the entrepreneur's mind?


OK I get what you are saying. I don't think it's a crippling blow to ABCT but obviously we're not going to settle the matter here. :)

Koppl said on another post:

"Is the order of a good (or the average period of production, or . . . ) "objective" or "subjective"? If it's "subjective," then why is it a problem if low interest rates lengthen the structure of production?"

Well, I think because even with the subjective theory of value we can have misallocation of resources. I think that the idea behind the ABCT is that the entrepreneurs subjective perception of the structure of production is distorted by credit expansion, in the sense that their perception becomes more distanced from the perception that they will have when they discover the information that they are bound to acquire with the passage of time. To say that is not to say that the capital structure is a objective entity, it only means that the entrepreneurs would know more about the consequences of their plans if they were more alert.

As the editor who published the piece I will say that there was some editing of it, presumably Samuelson's final word on Hayek, which I think deserves to be heard, for better or for worse. However, indeed, the editing was lighter than usual for a piece by a 92-year old of views at least as strong as those of his younger years.

Terrible Writing.

Hayek's work in the general area of production over time led to growth theory and to the intertemporal equilibrium construction, among other things. For example, read Hicks on the inspiration for his work, and Hicks on the inspiration for Harrod's work on growth theory -- in both cases it was Hayek.

Economists are simply ignorant of the history of their field.

Someone wrote:

"Whatever the truth about Hayek´s capital theory, Samuelson is correct in pointing out that it has had little or no influence within economics."

Roger wrote:

"Hayek himself said, in effect, that his book on capital was a mess."

Please tell us were, Roger. I haven't come across that.

I'll not that, when modern Austrians trash Hayek's _The Pure Theory of Capital_, almost never do they produce a substantive argument, or a do they do so along side of an explication of what is contained in Hayek's _TPTofC_. Instead, it's all hand waving.

Hayek never dis-owned _TPTofC_. And it contains Hayek's most extended account of his explanatory strategy in economics.

What Hayek said is that part IV of this _TPTofC_ needed to be a full length volume on it own, and instead it's just a condensed outline of what he needed to write.

Note well that Machlup wrote the brief arguing the case for Hayek Nobel Prize -- number 1 on Machlup's list of Hayek's most important contributions to economic science was his work on capital theory.

Thank you for your reply Roger. It's an interesting idea which i'll keep in mind while reading Hayek. However I don't believe that Samuelsons's criticism in the sentence I quoted was directed at Hayek's method but at empirical evidence that negated his theory. I'm wondering what empirical evidence he is talking about.

To Greg:
I know about Hicks´ references to Hayek in his _Capital and Time_. Can you provide some evidence about the influence on Harrod´s work on growth theory? Thank you in advance.
To Barkley Rosser:
The piece will be for better not for worse. The most important phrase in the paper is: "I was not at all the only one to be converted to the view that Friedrich Hayek was actually the debate´s winner." Voilà, le grand mot est sorti.
Samuelson who did not foresee the collapse of the former Soviet system now claims to have been convinced by Hayek of the impossibility of socialism!
Also ask yourself whether, say, Stiglitz would make such an assertion...


Yes, Machlup sure liked Hayek's theory of capital. He always lamented the neglect of Hayek's PTC. He repeated that lament often.

Hayek makes the comment I say in Hayek on Hayek, which I don't have available to me just now. As I recall he says so in the same bit in which he says Lachmann's book captured the essentials. The way I remember it, he basically says you should read Lachmann and not PTC.

Anyway, Greg, I was not "trashing" Hayek's book. All glory to Hayek in the highest. Nor am I repudiating Austrian capital theory. On the contrary, we need to retain Austrian capital theory IMHO. But there is a problem, a topological problem as it were, with the time structure of production. It's the "hole in the bucket" problem and we haven't *faced* it, let alone solved it. (I refer to the old Harry Belafonte song.) At least that how it seems to me. Again, I wish we would listen to Peter Lewin's suggestion to use the concept of duration.

"Could someone clear this up for me? Is this the same guy (Paul Samuelson) who writes for the Washington Post? Whoever the Post guy is, usually writes good columns. But then I read econ blogs / papers and hear about some crazed guy by the same name."

Jay, the Post columnist is Robert J. Samuelson. He's no relation to PAS. That's unfortunate. Perhaps he could have taught the "crazed guy" some ideas and theory about which PAS is clearly clueless.

1. Barkley --- it is a good thing for JEBO to publish Samuelson; just as it has been a good thing for EEJ to publish Samuelson, or the JEL, but it doesn't mean IMHO that Samuelson should be forgiven his own ignorance and arrogance. In fact, I think he needs to be exposed as the shallow thinker and biased scholar that he was (is). Reading the first edition of Economics, really communicates to the modern reader (a) how much more was expected of college freshman then from what we expect from them today in terms of reading and understanding, (b) how upside down the world was in 1940s in terms of ideology and why Mises and Hayek had to fight the battles they chose to fight with Omnipotent Government and The Road to Serfdom, (c) how upside down economics was becoming with excessive aggregation and the confusion of macroeconomics and the pushing aside of microeconomics, and (d) finally how Samuelson actually wrote sentences in his Economics which could be almost lifted unedited by Ayn Rand and put in the mouth of her "darker" and less heroic characters in Atlas Shrugged. Lets have this discussion professionally. And if we shift to Foundations, we have in more things to discuss about the pure science of economics and leading it astray and with an arrogance in doing it that is perhaps unmatched at any time in the history of the discipline. To me Samuelson (more so than even Keynes) is the great divergent force in modern economics --- the great intellectual mistake of the 20th century. That's a debate we need to have as professional economists. That is why I would recommend that Robert Nelson's Economics as Relgion.

2. LVDH --- you set the bar way too low; of course mainstream economists know Hayek, he won the Nobel Prize and he was a main opponent in two debates. And lets remember that prior to WWII, the center of economic research and graduate education was NOT in the US, but in Europe and in particular in the UK. Oxford, Cambridge and the LSE were more established as centers of economic knowledge than Harvard. The rise of the US comes with the movement of European intellectuals to the US, and the investments that were made in higher education to attract talent to economics.

3. Roger --- I don't think Hayek says the Pure Theory is a mess, as much as he says it is incomplete -- awaiting a second volume which integrated monetary theory with capital theory. BTW, our "debate" about the relative importance of different works of Hayek really could be summed up on this point --- I'd rather young Austrians concentrate on the Pure Theory of Capital, rather than The Sensory Order. Of course, they should read both for a full understanding, but in a world of scracity which one should be the priority.

4. Greg is correct that Hayek's work had a significant influence on the development of contemporary technical economics which is overlooked by formalistic thinkers. Hayek provided inspiration to "theorists" ranging from intertemporal equilibrium to mechanism design theory. When guys like Krugman make pronouncements on Hayek's lack of influence, he has a sillynomics notion of Hayek's theory of the business cycle combined with a prior that thinks Hayek really only wrote The Road to Serfdom. Krugman just doesn't get it --- he should read L. Hurwicz or T. Koopmans. Stiglitz, btw, in his Wicksell Lecture has a section entitled Stiglitz vs. Hayek, he doesn't do that for any other economist. Stiglitz gets it, even if he disagrees; Krugman just doesn't get it (and personally I think that is true on numerous margins see my discussion of his Nobel Prize both on this site and at Forbes).

5. Dave Prychitko probably remembers this, but when our teacher James Buchanan won the Nobel in 1986, we had him next term for Constitutional Economics. One our bureaucratic classmates told Buchanan in class that Samuelson was on PBS and said in response to Buchanan winning the prize that he wasn't sure what Buchanan had done since "the theory of clubs". Samuelson was unwittingly admitting he knew absolutely NOTHING about public choice theory and its implications for public economics in general, and public policy analysis in particular. An entire 2 decades of research in economics that revolutionized a discipline. Buchanan just said "Poor Paul, he has lived long enough to realize just how irrelevant he really is."

Buchanan (and Tullock) operated on that "thin line" that is irreverance toward the "establishment" while maintaining a serious commitment to publishing in the top tier outlets and influencing the professional conversation.

I just read Samuelson's paper for a second time. I'm reminded of Twain's supposed comment on Wagner's music. "It's not as bad as it sounds." Samuelson did himself a disservice by striking an unpleasant tone, but he's not making a completely bogus argument.

Samuelson gives us his personal scorecard on Hayek. Hayek won the socialist calculation debate and invented information economics in the process. His trade cycle theory makes no sense because his capital theory is a jumble on which he worked nobly, but to no avail. His idea that the welfare state would sink inevitably into tyranny is belied by history. Overall, though, he was a "worthy choice" for the Prize.

Me too, I'd rate Hayek better than that. But 1. there is a problem with capital theory and some of Hayek's greatest admirers don't go for his cycle theory. 2. Hayek did at least *seem* to say that the welfare state puts us on a really slick slope that ends in hell. Here, too, I rate RTS waaay higher than Samuelson. I'm just saying that a fair-minded person could reasonably think Hayek exaggerated the dangers of interventionism. Overall, then, it's higher praise than we might have expected from either Cambridge and the harsh bits are based on something real rather than merest intellectual bigotry.

"Of course" mainstream economists know Hayek? But do they also know which achievements he reveived the Nobel Prize for? I doubt it very much. He is still much better known by legal theory types etc. for his spontaneous order work etc. Many economists still don´t know his work on business cycles is actually among the contributions for which he received the Prize. This is because most economists simply assume that anything valuabe in his work must somehow have been incorporated into the mainstream... Thus Samuelson´s paper is probably still representative of the actual view of many mainstream economists about Hayek today, which does of course not mean it is acceptable from a truly Austrian viewpoint. Nor does it mean the bar should not be put higher of course. Note also that most of the less flattering elements in the paper are actually points Hayek himself admitted or at least would not contest, e.g. that he spent years in the wilderness, that he could hardly follow up on recent developments in mathematical economics etc.
As is clear from Samuelson´s aseessment the most important misunderstanding concerning his business cycle theory - besides capital-theoretic issues - is the confusion between the the theory of the unsustainable boom, and the theory of depression, and both Mises and Hayek bear some responsibility for this. I have more than once drawn attention to this before.


I am probably going to post on econospeak soon about some other substantive matters on this, but I will make a couple of comments here now. In particular, I will make it clear that I have long disagreed with Samuelson about many things, and he knows it. The first time I met him (1971), I gave him a hard time about capital theory, particularly aggregation and the "doughnut hole" problem, as Roger Koppl puts it. He brushed me aside with basically saying "the critics are right, capital is heterogeneous, and we must deal with it."

Regarding capital theory, it is somewhat ironic that in The Pure Theory of Capital, which I gather is (or was, maybe it is getting stressed again) the least read of Hayek's major books, he confronted some of these problems, even if he did not fully solve them. The irony is that these are the same sorts of problems that Keynes's "bulldog against Hayek" (on macroeconomics) Sraffa would push in his Production of Commodities by Commodities, that provided the basis for the Cambridge controversy in the theory of capital critique of Samuelson's views of capital theory.

Regarding the matter of Hicks and Harrod, it is clear that Hicks became a fan of Hayek in his later work. It is not so clear with Harrod, and Kevin Hoover and others are currently studying the matter of the origins and nature of Harrod's growth model, which has several different versions, just to complicate things. But I would warn that to the extent Harrod was influenced by Hayek, he was also more certainly influenced by Keynes. Indeed, the not-very-accurate textbook characterization of the Harrod-Domar growth model is that it married a Soviet-derived growth model by Fel'dman (ultimately drawn from Volume II of Capital by Marx) with a short-run model by Keynes, although it was through Domar rather than Harrod that the Soviet-Marx part of that came in.

Oh, and most would argue that Irving Fisher beat out Hayek on the intertemporal equilibrium idea, even as it can be argued that he also beat him and Sraffa out on the "hole in the doughnut" problem in capital theory, while also not resolving it. Heck, it remains unresolved now.

The *bucket* has hole in it, dear Barkley, dear Barkley. The *bucket* has a hole in it, Barkley my dear. :-)

"Also ask yourself whether, say, Stiglitz would make such an assertion..."

Have you read Wither Socialism? He has admitted it.

Yes, but it´s quite a long time ago. If I remember well, he actualy criticized Hayek in Wither Socialism. So you say he admitted Hayek actually proved the impossibility of socialism? Great! Thanks for reminding.


Is the point of bringing up the hole in the bucket idea just to remind us that Austrian capital theory is, so to speak, an unfinished good? ;)


He praises Hayek more than he criticizes him, and he essentially says he was right about everything. His main criticism of Hayek and Austrian economics is that it has no formal models:

"My concerns are two-fold: First, because Hayek (and his followers) failed to develop formal models of the market process, it is not possible to assess claims concerning the efficiency of that process, and second (and relatedly), in the absence of such modeling, it is not possible to address the central issue of concern here, the mix and design of public and private activities, including alternative forms of regulations (alternative "rules of the game" that the government might establish) and the advantages of alternative policies toward decentralization-centralization."
(p. 25)

But otherwise he says he basically agrees with Hayek's analysis, and he says that with market socialism, technological change makes the communication of price signals to the planner break down. He says "It s here that perhaps Hayek's criticism of central planning becomes most relevant. It is essentially impossible for all the relevant information to be communicated to a central planner. There really is no alternative other than some form of decentralization and a far more fundamental form of decentralization than envisaged by the market socialism model."
(p. 152)

He also admits Hayek's was proven right in practice: "Perhaps the most important reason for failure was the very reason that Hayek argued central planning would fail: The central authorities simply did not have the information required to run the entire economy." (p. 198)

"He praises Hayek more than he criticizes him, and he essentially says he was right about everything."

Liberty, I think that it can be said more about some idea beyond right or wrong. Stiglitz said that the ideas of Hayek contained important insights. Not that they were right in every nuance and all of its implications. If Stiglitz had fully agreed with Hayek ideas on socialism, he would be libertarian.


There is a distinction here, yes. He admits that Hayek's conclusions about socialism were correct, but disagrees with his methodology.

As the quote above explains, Stiglitz thinks that Hayek's methodology prevented the economist from determining the degree of inefficiencies, or the result of mixed public and private provision. Essentially, he argues that the Austrian methodology is great for analyzing pure systems and coming to broad conclusions, which may have great insight (and he admits Hayek's insights were great and were correct); but were limited to that purpose.

He is not convinced that the same insights necessarily apply to interventions and mixed economies. Mixed economies can make use of markets, perhaps a little bit of intervention doesn't suffer from all the same problems as planning and market socialism, and if markets are not perfect them perhaps this intervention will be better than the market left alone. He doesn't feel that Hayek has disproved this, so he is not made libertarian by Hayek's work.

But, although he criticizes the perfect competition model very insightfully, he still thinks that government must intervene to get the market closer to perfect competition, essentially. This may be due to just being steeped for so long in these models.

Hicks is very clear about the fact that Hayek was the one who made him think about processes in time -- how Hicks went about it may be another matter. And we're talking about the 1930s here, not the 1970s. Ditto with Harrod -- Hayek made his thing in terms of processes through time, the specific "tools" no doubt came out the Marshall framework.

The English had a terrible time escaping from Marshall -- and essentially never did. Maybe Lerner in his Walrasian socialism is an exception.

What so many of these economists seem incapable of doing is telling us what other economists were like as human beings, and what happened at particular times.

Samuelson was there when Hayek presented his "The Use of Knowledge in Society" paper to Schumpeter's seminar. What was that like? What happened?

Hayek left out the material targeted at Schumpeter, which appeared in his 1945 article as published. What was Schumpeter's reaction to those criticisms?

What would be interesting from Samuelson in an article on Hayek is mostly missing here.

Roger and Barkley,

Iron and coal are not used to produce iron and coal, at least not these days. Coal mines buy electricity from coal-fired utility plants these days, but the only coal you'll see in a coal mine is either in the ground being mined and processed, or above ground awaiting shipment to a utility or other user of coal. Their equipment might be produced by iron-using equipment manufacturers, and the equipment they buy might have iron components, but you won't see raw iron as a good-in-process in a coal mine.
Ditto for an iron company, mutatis mutandis.
So much for the hole in the bucket problem.
I would suggest reading Murray Rothbard, _Man, Economy, and State_, which I think has one of the simplest and best expositions of Austrian capital theory. Admittedly, he was off base on money and banking, so you'll have to go to George Selgin for that.

And a word about Sraffa. I get heartburn every time I see him mentioned in a discussion of economics. He had a bizarre idea of a "rate of profit." (It must have come from Marx; I think his fellow Marxoid Joan Robinson used that term also.)
As Rothbard pointed out, there's no such thing as a rate of profit (or loss!); profit (loss) is a an entrepreneur's gain (loss) for correctly (incorrectly) forecasting revenues and costs in a business.
He would have been on firmer ground talking about a rate of interest. If you borrow from a bank, the loan officer will write you a contract calling for a certain payment on the outstanding loan balance, so it makes sense to talk about a rate of interest.

Ahhh. Thank you very much!

Paul versus Robert. Besides having no letters in similarity between one another, they're basically the same first names, right? ;-)

When put into context, one cannot be content with Pete´s simple assertion that Samuelson is obviously "silly" and "arrogant". These are not the terms of a professional discussion. Austrians should rather seize the opportunity offered by Samuelson´s paper to detect where exactly the mainstream percepton of Austrian economics still goes astray. But at the same time Samuelson does point to some real problems. When he says that Austrian business cycle theory did not provide an adequate diagnosis of the Great Depression, he has a point - and the Keynesians did have a point - since the theory is not exactly a theory of depression. Some of the same or similar errors are continued or repeated today by Austrians...

I also maintain the view that Samuelson´s acknowledging that Hayek disproved or at least discredited the idea of central planning is indeed significant. Many standard textbooks - in particular when they treat the economics of information, incentives etc. - still implicitly adopt the viewpoint of a central planner. It would not be difficult to illustrate this, despite Stiglitz´ remarks in Whither Socialism. So apparently quite a few individuals, also among professional economists, still don´t get it. So yes, Samuelson has done the Austrians a favour by declaring unambiguously: Hayek won the debate! Why he does not include Mises, is of course a different question...

"When he says that Austrian business cycle theory did not provide an adequate diagnosis of the Great Depression, he has a point - and the Keynesians did have a point - since the theory is not exactly a theory of depression. Some of the same or similar errors are continued or repeated today by Austrians..."

ABCT does give a good explanation of the G.D.
If the Keynesian theory hinges on an "autonomous" drop in "aggregate demand," then exactly what point--valid point--did they have?
Samuelson, like Krugman and DeLong (who called Mises' work "batsh*t insane") clearly never read the Austrians, or if they did (which I doubt), they didn't understand them.
Samuelson is a hypocrite when he criticizes the Austrians for not gussying up their theory with math, because he dressed up Chuckie Marx's theory with math in at least one paper (I think it was in the JEL). Marx didn't use math in his work, just as the Austrians didn't. I guarantee you that if Samuelson had wanted to formulate Austrian theory with math, he could have done so. It would have been a waste of paper, but he could have done it.

If you read again Samuelson´s paper, you will see that he has at least a rough understanding of the theory, considered as a theory of the unsustainable boom: "Easy money now often does entail tighter money later which will come as a surprise to uncompleted projects..." But he also understands that this will not do as a theory of the Great Depression. The latter scenario simply does not fit into the classical framework governed by Say´s Law and the idea of a self-regulating, self-correcting economic system. In general terms this is a correct point. But it would be more correct to point out that it were the Monetarists who pointed to the monetary pre-conditions for the scenario. It were Austrians like Rothbard, Huerta de Soto etc. who pointed to a solution: an entirely different system is needed. But Hayek of the 1930s was still far away from conceiving any such solution. The bust following the boom may be necessary for the liquidation of the credit-driven malinvestments but it need not entail a massive monetary contraction and/or a depression. What is needed is a different system that would limit the scope for both inflationary and deflationary disequilibria.

"The bust following the boom may be necessary for the liquidation of the credit-driven malinvestments but it need not entail a massive monetary contraction and/or a depression. What is needed is a different system that would limit the scope for both inflationary and deflationary disequilibria."

Well, the size of the bust has something to do with the size of the boom that caused it!
That's why the current bust is so large--the credit boom induced by Easy Al was in fact the biggest one in history, at least according to The Economist.
You're right that a different system is needed. That would be free banking, which would put an end to the central-bank-caused boom and bust cycle.

Stabilizing the quantity of money - instead of letting it contract - should be sufficient to eliminate the malinvestments. The point is that if you let the quantity of money contract - as happened during the Great Depression - this will generate considerable "collateral damage", i.e. sound projects will be forced into liquidation. The practical problem is how you can do this without generating anew injection effects. I am not sure Hayek, say, at the time he wrote P&P, had a clear and correct picture of how the monetary system actually functioned during the GD.

Maintaining the quantity of money while malinvestments work themselves out only "works" if the demand for money is constant. If the demand for money rises during a Depression, then maintaining the quantity of money is better than allowing it to fall, as occurred during the GD, but it isn't sufficient. The quantity of money needs to rise.

On a different note, the version of ABCT that I learned claimed that constant monetary growth could not maintain malinvestments, and that ever increasing monetary growth is necessary to avoid unemployment due to the structure of production reshifting back to reflect consumer preferences for present vs. future consumption.

If such a policy (of accelerating money growth) was not followed, why wouldn't the malivestments be liquidated?

On a third note, what sort of things influence the natural interest rate? I have always assumed that abstracting away from monetary disequilibrium, anything that would impact the supply or demand for credit would be changes in the natural interest rate. Perhaps I am mistaken, but my impression that some "Austrian" macroenomics treat all observed changes in interest rates as being deviations of the market rate from the natural interest rate. Have I not been paying attention?

In White's discussion with DeLong on Cato Unbound, in passing, White says that changes in expections (well, I don't remember exactly) should be relfected in relative prices. DeLong, on the other hand made some claim about the proper level of interest rates and the rate of return on equities based upon estimates of time preferences, risk premia, and long run trends of productivity growth.

Does it just go without saying among Austrians that the natural interest rate is a market price that depends on all sorts of things? Is it rude to speak generally about what sorts of things?

And one final note. White's discussion of the Fed's expansion and the ABCT impact of the current crisis apparently didn't make obvious this very issue above--the difference between an unsustaintable boom and a deflationary wringer for the Depression. DeLong read White as proposing that the malinvestments must be liquidated, and we must suffer depression levels of unemployment.

Under free banking, the supply and demand for money shift to reflect the preferences of people who demand money, just like the supply of any other good or service adjusts to consumer demand.
During the GP, we didn't have free banking; Hayek's work during that time didn't reflect the free banking revival of the 1970s that he did so much to encourage ("Choice in Currency"/"Denationalisation of Money").
Right re: White, who I thought gave the game away by including non-causal elements in his explanation of the boom, such as the Communty Reinvestment Act of 1977, which "the fattest economist alive" (Donald J. Luskin's term, and it's so right on!) later refuted in his blog.
I don't remember is White was arguing that the malinvestments should be liquidated--maybe he was--, but I would agree with that position.
It doesn't follow that we would have unemployment of 25% and a G.D. redux the way Thugman evidently thinks.

Bill Stepp,

We had something approximating a gold standard with pretty free banking during the late nineteenth century in the US. We had major recessions/depressions in the 1870s and 1890s, not to mention prior to the founding of the Fed, the "Rich Man's Panic" of 1907. Many have noted that the worst of these, the 1870s debacle, was preceded by a major speculative bubble that crashed, with this probably the worst economic downturn in US history except for the 1930s.

So, do you wish to explain, please, exactly how it is that free banking avoids such episodes?


Guess I am not sure what the "leaky bucket" theory is. Did a google on it and got nothing that related to Hayek on capital theory. Is this a term he used, or maybe Roger Garrison?

I made up the "doughnut hole," and while I may be corrected by Greg or Pete or somebody else, my take on the capital theory situation is that in his Pure Theory of Capital Hayek became aware that it is very hard to come up with an unambiguous measure of the "average period of production" that had lain at the base of the Bohm-Bawerkian theory in a world of complicated time streams of returns, or time structures of production to be closer to Greg's terminology, with this being especially true when net returns can oscillate over time between being negative and positive. Fisher called this the problem of "multiple roots," and it is the key also to the "capital-reversal" phenomenon of the Cambridge UK crowd led by Sraffa, with reswitching being the poster boy example.

After he "lost" the dispute in 1966 in the QJE over the generality of this phenomenon, Samuelson wrote in his surrender piece that "economic theory is based on foundations of sand," and his remarks to me in person in 1971 reflected this view, even if empirical economists have continued to mindlessly run around estimating growth models based on aggregate capital in simple-minded production functions, and Greg Mankiw has managed to infect the textbooks with this simple-minded model as the superior approach to teaching macroeconomics, gag.

As for me, well, my more extended discussion of this can be found in Chap. 8 of my From Catastrophe to Chaos: A General Theory of Economic Discontinuities, either edition, although I published several papers on it earlier, including one that was sort of annoying for your old mentor, Roger, even if he appears to have forgiven me... :-).


I invented the term, though it seems to be a poor choice. I was getting at just the issues you cite. I thought of the old song wherein the bucket has a hole, which much be patched with straw. To cut the straw you need to sharpen the ax on a wet stone. But because you can't wet the stone because the bucket has a hole in it. I recognize that the bucket problem is not isomorphic, but I thought the way the song circles back might be suggestive of the problem. I no longer think so.

Oh, and I know you have yet to see the light regarding Leland's analysis. Being the magnanimous type, I forgive you. :-)


Those panics are explained precisely by the fact that we did NOT have a "free enough" banking system. As my own work on the panic of 1907 (and my book chapter on the NBS more generally) point out (as have others before me), the combination of legal reserve requirements, limits/prohibitions on branching, and *esp* the bond-collateral requirements for currency issue was more than enough to prevent the supply of money from responding to changes in demand, including the c/d ratio, in the ways it should have.

Using those episodes as evidence against free banking just ain't gonna fly given the kinds of government interventions that still existed. You're going to have to show how those problems would have happened without them. Observers at the time understood the problems, especially those at the Indianapolis Monetary Convention in 1897. Their proposed reforms would have helped a lot and probably prevented the 07 panic.


Good reply. I knew somebody would come up with that counterfactual that remains unproven, :-).

How does the argument hold for the 1870s?

Well the existence of significant gov't regulations on money creation at the time is not counterfactual. ;)

To be honest, I don't know the 1870s stuff as well as the 1880s-1900s, other than to say the same regulations were in place. I'm not sure enough about what I do know to say whether they mattered the way I know they did later on.

Barkley Rosser,

I'm not an economist at all and I think it's quite clear that what Steve and others call "free banking" did not exist at the time you claim it "kinda, sorta, maybe did". It didn't.

I enjoy reading Samuelson's take on Mises, Hayek et al. At least he's read the Austians unlike most neo-classical economists.

The little tidbits are interesting too like the fact that Schumpeter and Haberler were his "mentors".

I don't have Stepp's faith in free banking. My view is that a wise central bank could do better, but a foolish one, like in the GD, can do much worse.

That said, I must respond to Rosser. The late 19th century banking system was't anything like free banking. An almost complete restriction on branching, hefty legal reserve requirements, banknotes issues only by national banks using U.S. bond collateral....

It is true that the ban on the option clause was mitigated because suspensions occurred anyway.

The "orthodox" view among free bankers is that foolhardy bank regulations in the 19th century made central banking look good.

Barkley Rosser,

Most monetary historians date the "free banking" era in the U.S. (such as it was, and it wasn't really free like Scottish free banking because of state bond deposit requirements and other interventions) from 1838 to 1863. The National Banking Act of 1863 set the stage for taxing state bonds and private bank notes out of existence (starting in 1866). The latter were replaced by national bank notes ("greenbacks"), and the newly created comptroller of the currency took charge of monetary policy, which was preempted in 1913 by the Fed's control of monetary policy.
So I would agree with you that there was something approximating a gold standard, but would disagree that the U.S. had anything approaching free banking.
The government overexpanded the supply of bank notes in the 1860s, and later contracted the money supply. The panic of 1873 was not caused by a non-existent laissez faire in banking.
The panic of 1907 was aided and abetted by the Tresury's "quasi-central banking operations," which had happened over a long time, as William L. Silber puts it in his recent book, _When Washington Shut Down Wall Street: The Great Financial Crisis of 1914 and the Origins of America's Monetary Supremacy_, p. 53.
Gold imports from Europe made the crisis less severe than it would have been, but they came too late to stop it.
The Hepburn Act also put a hole in the stocks of railroad outfits, which at the time accounted for an outsized portion of the stock market's total capitalization. Also, an overexpansion of credit had caused a railroad boom.

Free banking might not completely solve the problem, but if George Selgin is right in saying that from 1793 to 1933 only seven of the world's forty-one banking crises occured in countries with banking systems approaching free banking, then it seems fairly clear that such a system is at least as good as any alternative.

Bill Stepp:

You're a bit confused about the post-1863 era.

1. The NBA of 1863 did not "tax private bank notes" per se. It taxed the private bank notes issued by *state-chartered banks*. (Technically that was the amendment to the Act in 1865.) This was because the 1863 Act allowed federally-chartered banks for the first time, but no one wanted to be one as it offered no advantage over the state charters. Congress taxes state-chartered bank notes and voila!

2. "National bank notes" and "Greenbacks" were *emphatically NOT* the same thing. Greenbacks were in fact gov't issued fiat, but they comprised a relatively small percentage of the money supply.

National bank notes were issued privately by *federally* chartered banks, hence "national bank" notes. It was these notes that comprised the bulk of hand-to-hand currency and it was these notes that were subject to the problematic bond-collateral requirements that Bill W and I have both mentioned. What screwed up the NBS was the inelasticity of the currency produced by those requirements.

3. The Comptroller was not in charge of monetary policy. The Comptroller's office WAS in charge of physically creating the national bank notes once the banks provided them with the required collateral, but the notes were very clearly liabilities of the private banks and variations in the money supply were not a matter of policy from the Comptroller's office.

You can read more about the Panic of 1907 from this perspective here:

Your general claim is right here Bill, but I think it's important to get the details right.

Let me add a general point for our readership:

I think it is SO important to get your monetary history correct and get it from reliable sources. There's so much monetary crankism out there and there are all the Fed conspiracy theories etc.. The LAST thing that serious defenders of free banking should want is to be confused for the crazies. Don't get your history from popular treatments, and certainly not anything that smacks of Fed conspiracy theories (and certainly not "it was the Jews" ones). Read real economic historians and get the details right.

Monetary issues are hard ones and among the most easily misunderstood by people you might talk to. It's vitally important that we not sound like crazy folks. When we don't get the details right, we will be dismissed as "batshit crazy." And sometimes rightly so.


Thanks for the corrections and the link. Re: the 3rd point, I read somewhere that the comptroller of the currency was in charge of monetary policy, but I don't recall the source. I'll take your point in it's place.

And a comment to Woolsey: my defense of free banking is not faith-based. Do you seriously think central banking is as stable as free banking? If so, what is your (historical?/theoretical?) source?

Bill S: Another great source here is Dick Timberlake's much under-appreciated *Monetary Policy in the US* (I think that's the title), which came out in the early 90s.


One of the best introductions to the whole span of US monetary history around. Very accessible and written from a free market perspective.


Yes Timberlake's book is very good. I'll have to dig mine out from under the rubble, after checking to make sure my insurance is paid up.
Btw, have you read Charles W. Calomiris's _U.S. Bank Deregulation in Historical Perspective_?
I'm betting it's good; he had a great WSJ op-ed a while back about the myth of bank deregulation-as-cause-of the current mess.
And did you see the article in the WSJ on Keynes the week before last, which cited a 1934 restaurant incident in which he swept a pile of towels on to the floor, claiming that this would help stimulate employment in the restaurant industry?
I sent a letter to the editor, so far unprinted, blasting this nonsense, citing among other things the broken window fallacy.
I wonder if Skidelsky, who I haven't read, mentions this in his bio?

To Bill Stepp:

I didn't mean to be rude with the remark about "faith." Perhaps I misread your remarks, but I read your claims about how things would have worked out in the GD with a free banking system as being close to perfect. I am not so optimistic. I just think it would have been better than what actually happened.

As for central banking vs. free banking, it all depends on the central bankers thrown up by the political system vs. the details of market conditions for the medium of redemption used by the free banking system.

"but if George Selgin is right in saying that from 1793 to 1933 only seven of the world's forty-one banking crises occured in countries with banking systems approaching free banking, then it seems fairly clear that such a system is at least as good as any alternative."

How many countries had anything "approaching free banking" at the time? I'd be interesting in percentages her, rather than just raw numbers, i.e. 60% had free banking, but only 40% of crises occurred in those countries.

Pardon if this is a stupid question, but why not envision capital structure as a graph, with each node being a piece of capital and each edge being a connection from one piece of capital to another? In this form, a consumer good would be one which only had edges leading into it (i.e. it didn't supply anything, and only exists to be consumed) and the highest-order of goods would be one with only edges leading out of it.

Each edge would represent a business relationship and plan which allows one piece of capital to supply another. If the economy went through widespread restructuring of its capital, these edges would have to be reconnected, a costly process which would reduce or eliminate the edges connected to some nodes (perhaps permanently or perhaps just temporarily). A node without sufficient input or output would of course be (partially or fully) idle.

Of course, the standard Austrian stages of production can be seen as an abstraction of a graph like this for one low-order specific good, so this approach wouldn't invalidate the old one. But those stages don't help us understand reswitching, that piece of capital's relation to other goods, or the capital structure of the economy as a whole. I don't view this abstraction as being incorrect per se, but simply limited in its application.

I believe changes in the rate of interest would still be seen to lengthen the stages of production for a consumer good.

Using a model like a graph, I think it would be easier to show why some resources are under-utilized or left idle when the economy is rearranging its capital structure. It may also open up the possibility of using formal models, which may increase the persuasiveness of Austrians with other economists.

Only a small handful of countries had something like free banking systems. Kurt Schuler wrote an article called "The World History of Free Banking."


IMHO the objective capital structure requires a formal model inherently, quite apart from PR. Math comes up short when we are describing human action. If we don't use "hermeneutic" categories, we lose information. But when we are describing the meaningless unintended consequences of human action, there is generally advantage in describing such patterns with mathematics.

Anyway, have you had a chance to think about how your idea differs from an input/output table? It's a suggestive notion, but looks like such a table at first glance.

Hey! I edited that paper, after it got written.

To Bill Woolsey:
You raise several interesting points into which I cannot enter here extensively but note that instead of focusing upon the demand for money - which really covers different kinds of cases - I would point out that historicallly the problem has been one of what Yeager has called "the perils of base money". During the Great Depression for instance the problem was really that people fled into a safer kind of money which led to a cumulative contraction. So what is needed is a kind of monetary system which eliminates this kind of problem.

And what if the system that could eliminate that problem (presumably by eliminating fractional reserves?) causes a bunch of other problems? It seems to me the worry about mass conversion into base money is sort of like "what about the children?!" It suggests a corner solution where all other elements of a good banking system should be sacrificed to ensure we can't get that kind of run. Suffice it to say I don't buy it.

It also ignores the question of whether outside/base money runs are usually the product of bad regulations/law rather than somehow inherent in fractional reserves. The runs associated with the Great Depression were a combined product of central bank mismanagement and a banking system that was burdened by regulations that prevented a better response.

Yeager is often right, and certainly on this point. I didn´t say no other elements count. Where did I say that? You are right that central banking and unnecessary regulations are to be eliminated too. But on the matter of what constitutes unnecessary regulations, as you know, some disagreement and debate continue.
But the frequent reference to "demand for money" considerations is a bit repetitive. Different phenomena are covered here which can, and in my opinion, should be distinguished.
Can you provide the references to your historical papers on free banking? I am preparing another critical paper and I will consider your arguments.

HEre's the 1907 paper:

The longer treatment is in my first book, which can be hard to find: Monetary Evolution, Free Banking, and Economic Order, Westview 1992

You might also look for these:

“Government Intervention: Source or Scourge of Monetary Order?” review essay on Charles Kindleberger's Manias, Crashes, and Panics, Critical Review, 7 (2/3), Spring/Summer 1993, pp. 237-257.

“Systemic Rationality and the Effects of Financial Regulation: Rejoinder to Kindleberger,” Critical Review, 8 (4), Fall 1994, pp. 615-621.

And from the ancient days:

I am not sure runs are primarily related to bad regulations. They are related to loss of faith of banks´ depositors/creditors in banks´ solvency due to deteriorating conditions on the asset side of banks´ balance sheets. The latter must be related to malinvestment following credit expansion. So the first thing you should establish is that the causal chain credit expansion -> malinvestment would disappear under free banking. But under the hypothesized working characteristics of free banking this would not be the case, as I demonstrate in my paper "The Uneasy Case for Fractional-Reserve Free Banking".
The same causes have the same consequences, unless there are good reasons to believe otherwise...
Under free banking there is no direct and effective way to respond to changes in money demand via expansion of the inside money supply. In the absence of regulations and institutional barriers to price flexibility, real balance effects would operate to eliminate monetary disequilibria due to changing demands to hold inside money.

I have the text of your first book; if I remember well, I cited it in my paper "The Uneasy Case etc..."
Thank you for the other references.

The reference for my paper is:
Ludwig van den Hauwe, 2006, The Uneasy Case for Fractional-Reserve Free Banking, Procesos de Mercado - Revista Europea de Economía Política, Vol. III, Número 2, 143-96.

Note also that it is rather paradoxical that free bankers do not rely more extensively on real-balance effects for the elimination of monetary disequilibria due to changes in the demand to hold money. From a free market perspective, the real-balance effect is one of those self-regulating, self-correcting mechanisms par excellence, so characteristic of Hayek´s spontaneous order (in the monetary domain)...

"Under free banking there is no direct and effective way to respond to changes in money demand via expansion of the inside money supply."

Is it also true that under free markets there is no direct and effective way to respond to changes in product demand via expansion of the inside product supply?

If the latter is not true, can you explain why the former is? I am being serious.

To me the answer to your query is obvious - in fact to raise the question is to answer it - but let´s wait and see whether anyone else on this blog wants to add anything.

I'm not going to respond because I think the quoted statement is just false.

I am less interested in whether the statement is wrong than in the reasons offered for considering it wrong.
Consider the following situation. Some market participants, say a, b and c, reduce their spending of inside money issued by free Bank X,
which as a consequence experiences positive clearings, sees its reserves increase, and decides to issue additional inside money, say, in the form of loans which are granted to market participants x, y and z who immediately spend the money. Whose demand for money has the Bank X thus satisfied through the expansion of its issues?
Note that, whatever the answer, the situation is in any case different from the one in which, say, a car seller/producer sells cars directly to specific market participants who have increased their demand for cars.

Perhaps I'm confused. A, B, and C have increased their demand for inside money by having reduced their expenditures. By holding additional quantities of inside money, they have provided to bank X an additional quantity of loanable funds that it can now lend out and that will enter the spending stream.

The bank has met the rise in the aggregate demand for its money by increasingly the supply thereof. In quantity theory terms, V has fallen and the bank has responded by increasing M, ensuring that the total spending stream stays the same and that monetary influences are neutral toward the price level and that the market and natural rates do not diverge.

The bank has satisfied the increased demand for its money by A, B, and C by increasing the real money supply via the nominal supply rather than a falling price level. Without its action, the only way to satisfy that higher demand for inside money is through a decline in the price level due to the reduction in MV. What free banks do is exactly that: avoid relying on the price level to equilibrate mismatches in MS and MD.

And THAT is different from regular goods and services markets. This is the Yeager point: money has no market and price of its own, so monetary disequilibria must be addressed through either changes in the price level (i.e., ALL prices) and the microeconomic discoordination that will bring, or by changes in the nominal money supply. Unlike goods markets, we don't have "a" price that can adjust in the money market.

I got everything you said until the last paragraph... this may sound dumb, but: doesn't money have a price- the interest rate on loans? No goods market has "a" price, but money has a price as much as anything else, the price of each loan, right? Why can't the loan price change instead of the money supply?

The interest rate is the price of credit (or time-in-the-form-of-money if you want), not the price of money. That difference is absolutely crucial to understanding monetary economics in my view. Money proper has no market or price of its own. Loanable funds do, but not money. Read Yeager's "Essential Properties of the Medium of Exchange" on this.

I don´t buy Steve´s account. Let me try to "deconstruct" Steve´s account by "going back to phenomena" (to use a famous philosopher´s phrase).
(1) The bank, by issuing additional bank liabilities, hasn´t satisfied anyone´s increased demand to hold bank liabilities. It has simply taken an autonomous decision to increase its circulation. A, B and C have satisfied their own demand to hold inside money by simply refraining from spending it - say, by keeping money tickets in their pockets instead of spending them. Any market participant can at any time decide to hold as much or as little of the actual medium of exchange - in nominal terms - as he or she sees fit. In conventional monetary theory the process of reconciling the demand for money with its supply is sometimes referred to as "the fundamental proposition of monetary theory".(See on this e.g. Rabin, Monetary Theory, Chapter 3, who generally follows Yeager.) The process through which incomes and prices adjust to make the total of desired nominal cash balances equal to the actual money stock is also known as the Wicksell Process. One could perhaps argue that it is nevertheless a desirable policy choice to let banks expand the circulation in certain circumstances. Yet there is no way one can say - except through a dubious and unconventional stretching of the meaning of words - that the bank in the scenario sketched above has satisfied an increase in the demand to hold inside money.
Note also that the decision of A, B and C to hold on to larger quantities of inside money, thus satisfying their demand for it, in so far as it does not by itself alter the consumption/investment proportion (in other words their time preference remains unaltered), does not lower the natural rate of interest. The autonomous decision of the free bank to increase the circulation, say, through the granting of loans, may lower the market rate below the natural rate, however, and generate an injection effect. It is not easy to interpret this adequately, however, since in the model of the free bankers, a bond market is lacking.
There is nevertheless an important difference with a monopolistic money issuer: a limit is drawn to an individual free bank´s capacity to expand the issue, as Mises already pointed out. So here the free bankers indeed have a point.

(2) There is no way one can say, except again through some highly dubious and metaphorical use of language, that A, B and C, through the mere decision not to spend, have somehow entered into a loan agreement with the bank. In fact the only signal to the bank that somewhere in the economy an increase in the demand to hold its iabilities has occurred, will come through the positive clearings it may experience.
And yes, liberty: the interest rate is the price of credit, not the price of money.

"The interest rate is the price of credit (or time-in-the-form-of-money if you want), not the price of money. "

Thank you, Steve, for this clarification!

I'm going to be very annoying, though, and continue to ponder on this. I have always found monetary economics tricky, so please bear with me.

The thing is that it seems to me that it is still essentially the same thing. My time preference for money *is* my demand for money.

Money is the tool that is used to satisfy demand of all other goods. In general, it can be assumed that everyone has a general demand for it, because everyone wants *something* and money can buy everything (except love, right?) so it isn't the same as a demand for a fuchsia necktie.

Instead the "demand for money" is the demand for money *in whatever form the money is in* which includes how and when it is able to be used. The demand for bonds determines the price of bonds, the demand for cash determines the price of cash, the demand for credit determines the price of credit, and so on.

Yet, each of these impacts the other - it affects the price of the other. And so the demand for money-later (in whatever form) will affect the supply of money-now.

If I have a low demand for money-now (in the form of cash) this is because I have a low time-preference, and I don't mind putting off consumption for the time being. But this is in fact the use of cash - to consume-in-the-present. So, it is the demand for this form of money that is lower, and hence the price of this form of money must drop.

If the demand for money-now drops, then there are more holdings; those who want to borrow money to invest are offered lower interest rates because the bank wants to get rid of the cash. The price of money-now has fallen. It is cheaper (it will cost less in interest later) to get cash now. The form of money which is money-now is cheaper than before.

At the lower price, more people invest and pretty soon the price climbs back up, due to all the activity.

No need to print more money or restrict the supply, or anything.

Please explain why I am confused, or where you differ.


I think there's a whole bunch of confusion in your comment there that I just don't have the time right now to unwind. Let me just say that:

1. There is no such thing as a price for cash.

2. The demand for money is a demand to *hold* money balances, not spend them. If I have a low demand for money right now, it means I want to BUY things now, not put off consumption until later. I think you are thinking of the demand for money as going up when you spend it. In fact, it goes down when you spend it. Money is an asset, so our demand for it reflects our desire to hold our wealth in that form.

More later.

I apologize. I do not have any experience in monetary economics (obviously). I was using it to mean the opposite, the demand to take cash out of the bank, to spend it.

If my terminology were to reverse then, I still maintain my question. To say "there is no such thing as a price for cash" is just to dismiss my argument for why there is. However, I understand if you don't have time to explain why my argument is wrong.

"The demand for bonds determines the price of bonds, the demand for cash determines the price of cash, the demand for credit determines the price of credit, and so on."


A bonds is an iou, so it does have a price, which is determined by the supply and demand for
it (not just the demand alone). You can buy a bond at par (say) and pay $1000; that is it's price.

Interest is the price of credit, as Steve notes, and is determined by the supply and demand for it. If you borrow money from a bank, the loan office will quote you an interest rate payable on the outstanding principal, so that is the price of the loan.

Money on the other hand is different. You buy money by selling assets (or labor services).
Let's say you're a lawyer and charge a client $250 to draw up a will, which takes an hour.
You buy money by selling your services; but that doesn't establish a price for money. Money, unlike any other commodity, is simply a medium of exchange. Prices are quoted in money, but the latter doesn't have a price.
Even though there is a yield from money held, as Hutt put it in a famous article, that yield doesn't establish a price for money.

Bill Stepp,

Thank you for your reply. I doubt if my comment will be seen, since this thread is going off the front page, so I'll probably just have to hold onto my question, and read more, and get it answered eventually.

I understand all of your points, and I don't disagree with them. But I don't see them as addressing my point, still. The demand for cash (and its supply of course, as I did note in my question elsewhere) still must affect it. This is obvious, I think, when thinking about a fixed money supply. If its fixed, then there is only so much money to be lent out, and in circulation. When the demand for circulating cash changes, this could affect all prices (since it used in exchange) or it could affect interest rates, right? Because if I want to borrow money, there is a price I'm willing to pay to have the cash now.

Anyway, I thank you for your comment, and will get my question answered eventually.


the supply and demand for money determines the purchasing power of money, but is not a "price" of money. Rothbard is good on this in Man, Economy, and State (you have to read him with care, because he didn't understand banking and fractional reserves).
You can pay a price for oranges, say, $1.
But how would you pay a price for money?
Money is a medium of exchange; prices are expressed in money, but money doesn't have a price the way an orange does.

I will have to just read more on this subject, I fear I am coming off sounding very stupid, and am repeating myself because I don't understand.

You ask "But how would you pay a price for money?" and I am forced to reply, again, that I see the (time-relative) interest rate as doing this. If I want cash to buy my orange and I have no money, I pay $x in the future to borrow $y today to purchase oranges.

Just as the orange has a price, the $y has a price (although I don't pay it today). It is time relative, because the longer I ask for to pay it back, the more expensive it will be. But it is the money that I am paying for.

It seems to me that there are two components to the interest rate. There is the (supply and-) demand-for-cash component, and demand-for-time component. The latter is what causes the compounding of interest, but the former is the basis for the actual rate.

Nobody has commented on my critique of free banking, so I will take it that everybody agrees.

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