Thursday, January 30, 2014


2. Hayek - Sraffa debate and the fallacy of the “natural rate of interest”

The debate between Friedrich von Hayek, perhaps the most prominent representative of the Austrian School in the twentieth century, and Piero Sraffa, Italian economist who founded the Neo-Ricardian school, on the problem of uniqueness and consistency of the notion of “natural price” was curiously result (and somehow the continuation) of an earlier discussion between another two great economists: John Maynard Keynes and Lionel Robbins.

In the early thirties the intellectual environment of the University of Cambridge (England) was largely dominated by Lord Keynes who, by then, had already published his Treatise on Money and was working in The General Theory of Employment, Interest and Money. The professor Robbins, renowned liberal economist of the time, disagreed with the ideas of Keynes. However, he had failed to build until that moment a conclusive rebuttal of them.

It is precisely in this context that Hayek was invited to Cambridge. Joan Robinson, considered as the most important disciple of Keynes, describes the event as follows: “While the controversy about public works was developing, Professor Robbins sent to Vienna for a member of the Austrian school to provide a counter attraction to Keynes. I very well remember Hayek’s visit to Cambridge on his way to the London School. He expounded his theory and covered a black board with his triangles. The whole argument, as we could see later, consisted in confusing the current rate of investment with the total stock of capital goods, but we could not make it out at the time”. (2)

Thereby Hayek’s involvement in the Keynes-Robbins debate began to tip the balance to the side of Robbins. Keynes would had to overcome such criticism to continue successfully the project of the General Theory, but had little success in response: like other English economists, he had difficulty understanding and replying to Hayek given the little knowledge we had about the conceptual structure of the Austrian approach. And that's where Sraffa, with more knowledge of the Austrian tradition and invited by Keynes in 1927, enters in the debate.

The controversy between Hayek and Sraffa focuses, as has been said, on the issue of “natural price” which, of course, is central and relevant to the Austrian Business Cycle Theory since this theory postulates that crises are caused by Central Banks that artificially determine an interest rate below the level of the “natural rate of interest”. In 1932, Sraffa published in the Economic Journal the article “Dr. Hayek on Money and Capital” (3) and the same year Hayek responds with “Money and Capital: A reply” (4). Subsequently Sraffa replies with “Money and Capital: A rejoinder”. (5)

Sraffa’s critique is basically an internal critique, i.e., he analyzes the logical consistency and coherence of the Hayek’s argument. By doing this analysis Sraffa realize that there are serious logical gaps in Hayek’s theory and therefore is canceled all the explanatory value of the notion of "natural price" and also of the notion of “natural rate of interest”.

Specifically, the strongest Sraffa’s attack is to the uniqueness of the “natural price”. Starting from Hayek’s assumption about that money is merely a medium of exchange and by introducing the notion of “own rate of interest” for each good, Sraffa demonstrates the non-uniqueness of the alleged “natural price”. He writes: “If money did not exist, and loans were made in terms of all sorts of commodities, there would be a single rate which satisfies the conditions of equilibrium, but there might be at any one moment as many ‘natural’ rates of interest as there are commodities, though they would not be ‘equilibrium’ rates. The ‘arbitrary’ action of the banks is by no means a necessary condition for the divergence; if loans were made in wheat and farmers (or for that matter the weather) ‘arbitrarily changed’ the quantity of wheat produced, the actual rate of interest on loans in terms of wheat would diverge from the rate on other commodities and there would be no single equilibrium rate”. (6)

Thereby, considering the dynamics of the market, if there is only one disequilibrium between supply and demand of goods, the natural rate of interest on such goods will diverge with respect to the natural rate of other goods. Therefore, there is no uniqueness of the “natural price”.

In his reply Hayek, having had to admit the existence of multiple “natural rate of interest”, however says that they all are “equilibrium rates” (7). Sraffa is conclusive in showing the theoretical and practical difficulties of such a response: “Dr. Hayek now acknowledges the multiplicity of the ‘natural’ rates, but he has nothing more to say on this specific point than they ‘all would be equilibrium rates’. The only meaning (if it be a meaning) I can attach to this is that his maxim of policy now requires that the money rate should be equal to all these divergent natural rates”. (8)

Hayek’s attempts to revive the debate were sterile. Sraffa’s critique was too strong and the Austrian economists had to bear it for decades. In fact, it was not until 1994 that the prominent Austrian economist Ludwig Lachmann, defender of radical subjectivism, gave a relevant answer to the Sraffa's critique pointing out the ability of “entrepreneurial action” to eliminate the disequilibrium (9).

However, in an important paper in 2010 entitled “Multiple Interest Rates and Austrian Business Cycle Theory”, the Austrian economist Robert Murphy recognizes the inadequacy of the Lachmann’s solution: “Lachmann’s demonstration -that once we pick a numéraire, entrepreneurship will tend to ensure that the rate of return must be equal no matter the commodity in which we invest- does not establish what Lachmann thinks it does. The rate of return (in intertemporal equilibrium) on all commodities must indeed be equal once we define a numéraire, but there is no reason to suppose that those rates will be equal regardless of the numéraire. As such, there is still no way to examine a barter economy, even one in intertemporal equilibrium, and point to “the” real rate of interest”.  (10)

It is clear that there is no such thing as a “natural rate of interest” and therefore actually Austrian economists lack an objective parameter on which to base their argument that the crisis is caused because the Central Bank establishes a rate of interest “below” of “the” natural rate of interest. In fact, that leads us to the epistemological issue of falsifiability: given a lack of objective parameters, there is no way to determine if the theory corresponds to reality or not. One can understand the Austrians’ critique of the mathematization of Economics because this is not the ideal way to understand “complex phenomena” (11) but their rejection of the Statistic itself in the study of specific cases turns the theory in unfalsifiable and, therefore, puts into question its scientific character. (12)

To be continued


2) Joan Robinson, “The Second Crisis of Economic Theory”, The American Economic Review, vol. 62, Issue ½, 1972, p. 2
3) Piero Sraffa, “Dr. Hayek on Money and Capital”, Economic Journal, vol. 42, 1932, pp. 42-53.
4) Friedrich von Hayek, “Money and Capital: A reply”, Economic journal, vol. 42, 1932, pp. 237-249.
5) Piero Sraffa, “Money and Capital: A rejoinder”, Economic Journal, vol. 42, 1932, pp. 249-251.
6) Piero Sraffa, “Dr. Hayek on Money and Capital”, Economic Journal, vol. 42, 1932, p. 52.
7) Friedrich von Hayek, “Money and Capital: A reply”, Economic journal, vol. 42, 1932, p. 245
8) Piero Sraffa, “Money and Capital: A rejoinder”, Economic Journal, vol. 42, 1932, p. 251.
9) Cf. Ludwig Lachmann, Expectations and the Meaning of Institutions: Essays in Economics, Routledge Press, London, 1994, p. 154.
10) Robert Murphy, “Multiple Interest Rates and Austrian Business Cycle Theory”,, 2010, p. 14.
11) Cf. Friedrich von Hayek, “Theory of Complex Phenomena”, Studies in Philosophy, Politics and Economics, University of Chicago Press, Chicago, 1967, p. 22-42.
12) See: Karl R. Popper, La Lógica de la Investigación Científica, Tecnos Press, Madrid, 1980.

You can contact the author of this article in: “Dante Abelardo Urbina Padilla” (Facebook) and (email)

Thursday, January 23, 2014


1. Austrian Business Cycle Theory and the financial crisis

The global financial crisis is, without doubt, the most important economic event of our time. Its depth, extent and duration have led many people to put into question the free market and capitalism. This, of course, has resulted in a very heated debate about its causes (and possible solutions). On one side are those who call for more regulations, institutional improvement and implementation of Keynesian policies and, on the other side, those who argue that the current crisis is the fault of governments and Central Banks because they, and not the market, created the “financial bubble” that eventually had to burst. In the view of this group, the crisis is not sample of the failure of neoliberal capitalism but rather of the interventionist paradigm, the unregulated free market is still the perfect way to organize the economy and if there are problems is not because the market doesn’t work but because the State has not allowed it work. Among those who advocate this position are obviously the Austrian economists. In fact, this view is at present strongly promoted by prominent Austrians such as Ron Paul and Peter Schiff, who claims to have predicted the crisis.

The theoretical basis of these economists to support their position is on the Austrian Business Cycle Theory. According to this theory, originally proposed by Ludwig von Mises and Friedrich von Hayek, crises are the result of “distorting action” generated by the State to intervene in the market. So, as the coordination capacity of the market is destroyed, is necessary a painful process of “adjustment” to restore the “spontaneous order” and, consequently, the crisis comes.

This is in a very general and abstract level. However, the most interesting formulation of the Austrian Business Cycle Theory is about the crises caused by “credit bubbles”. Here the “spontaneous order” is the correspondence between actual savings and investments of private agents. In this context, the State, through the Central Bank intervenes in the market to “stimulate” the economy by relaxing credit conditions. To do this is applied a monetary policy that determines a rate of interest below the “natural rate of interest”, that is, the one that would be configured under conditions of absolute free market. In this new “artificial economy”, consumers have access to more loans and entrepreneurs make more investments with respect to what would occur merely on the basis of actual savings and then the bubble begins to emerge. At some point, as already said, this bubble has to burst and the economy will have to “adjust” itself, and the crisis occurs. All this does not happen through the fault of free market but rather through the fault of the State intervention.

Like most economists, Austrians developed their analysis of the mechanism of causation of the crisis taking as main reference the U.S. economy. Specifically, they argue that the financial crisis was caused in 2001 when, precisely in the context of economic depression and loss of confidence after the attack on the Twin Towers, the U.S. Federal Reserve, to “stimulate” the economy, reduced the interest rates from 6.5% to 1.75% and then to a minimum of 1% in 2003. Also in June 2002 the U.S. government announced would guarantee to the companies Fannie Mae and Freddie Mac to help create liquidity in a secondary market for mortgages so that the vast majority of families can access the “American dream” of own home. This, argue the Austrians, was what created the credit bubble which would trigger the financial crisis in 2008.

This is the Austrian view of the crisis. The liberal Spanish economist Jesus Huerta de Soto, the most famous representative of the Austrian School in Spanish-speaking countries, puts it this way: “Economic depression is not a crisis caused by the market economy. This is something we have to remove of our mind definitively. The crisis is not a crisis of the market, it is a crisis of state intervention, state intervention which produced the current banking system and credit expansion, which has deceived entrepreneurs, which has distorted the production structure (...). Therefore, in a free market economy does not have to exist economic depressions”. (1)

The implicit assertion that “the market is always and necessarily perfect, and the State always and necessarily is at fault” is too radical and deserves to be examined. And this is the subject of this article: make a critical analysis of the Austrian Business Cycle Theory in the context of the current financial crisis.

To be continued...


1) Jesús Huerta de Soto, “Una interpretación liberal de la crisis económica”, Estudios de Economía Política, Unión Editorial Press, Madrid, 2004, p. 157.

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Tuesday, January 21, 2014


The issue of “relational goods”

In fifth place is argued that as our income increases, or precisely because we strive to have more and more things, the consumption of so-called “relational goods” is reduced. Indeed, in an effort to make us richer,  our friends and the time we dedicate to our family are reduced. A perfect example of this we can find it in Mr. Burns, sinister personage of the famous series “The Simpsons”, immensely rich and miserable who has no family, no friends, only his assistant, Mr. Smithers, whom is often undervalued and ignored by him.

But the problem is that it is not only our ambition but also the inevitable development of technology what condemns us to this situation since every step toward technological progress transforms our dependence on other human beings in dependence on machines. “The devaluation of the human world grows in direct proportion to the increase in value of the world of things”, said Marx concisely (1).

Technology begins to offer us substitutes for human relationships: children do not need parents to raise and educate them as they have to television, computer, internet and video games; families no longer need to come together to share a nice meal because the microwave oven allows everyone to warm your own food and eat separately, the person who wants to have children does not need to meet and fall in love with a special someone, or build a nice family and get married, simply he may resort to artificial insemination or a “surrogate mother”.

But the most tragic thing is that we have realized too late that the love and human warmth so necessary for happiness, are not products that can be manufactured by a company or created by technology and it is very difficult to find the return path.

The problem of moral and spiritual degradation

Finally, and even more serious from a transcendent point of view, economic progress (in the way in which we live it) by their very dynamic tends to undermine the moral and spiritual conditions in which man can achieve his happiness. For how could a system based on boundless ambition, envy, selfishness, emulation and competition create a society of “good and happy men”? How could a “progress” which systematically encourage and justified as “rational” all these vices be the solution to the problems of man and be the way to a happiness necessarily linked to conditions of peace, love, solidarity and virtue? To pretend such thing would be like to believe that the best way to expel demons is to invoke Beelzebub, who is the prince of demons.

In this point is likely that someone thinks that I am demonizing economic progress. But that is not what I want to do. It makes no sense to oppose the economic development in itself because it can also become a powerful tool to deliver man from his material and moral poverty. But we must resist the current model of economic progress as being carried out today mainly in Western countries as it requires countless human sacrifices to the “god” of Development. It is time to understand that progress by itself, the mere economic efficiency, never bring peace and prosperity to man but rather can only do so if this progress is oriented. And this orientation must come from within us through a deep ethical and social consciousness.

So maybe we should not pay much attention to what Keynes had said about that, to reach the desired welfare, “we must pretend to ourselves and to everyone that fair is foul and foul is fair; for foul is useful and fair is not. Avarice and usury and precaution must be our gods for a little longer still. For only they can lead us out of the tunnel of economic necessity into daylight” (2). Rather we should seek a more human economic progress, based on qualitative things rather than quantitative things, and pay attention to messages as this one by John Paul II when he said: “It is not wrong to want to live better; what is wrong is a style of life which is presumed to be better when it is directed towards ‘having’ rather than ‘being’, and which wants to have more, not in order to be more but in order to spend life in enjoyment as an end in itself. It is therefore necessary to create lifestyles in which the quest for truth, beauty, goodness and communion with others for the sake of common growth are the factors which determine consumer choices, savings and investments”. (3)


1) Karl Marx, Economic and Philosophical Manuscripts, Madrid, 1970, p. 105.
2) Quoted by E.F. Schumacher, Small is Beautiful, Orbis Press, Barcelona, ​​1983, p. 24.
3) John Paul II, Centesimus Annus, 1991, nº 36.

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