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At least they published the letter.

:) That's pretty funny.

Look on the bright side - everyone that knows what you're talking about is getting a laugh at the expense of the Washington Post right now.

Everyone that doesn't know what you're talking about didn't even notice.

Unfortunately, Daniel, the first group of people is smaller by a magnitude than the second group of people, so they didn't even attempt to read the letter.

Once I read somewhere: I know that most Austrian are libertarians, but Austrian healthcare is public!

This is nicest absurdity I found out so far on Austrians.

Congrats on getting the letter in, although I am not sure I agree with you on the supposed motivations for establishing central banks. Were the Bank of Sweden or the Bank of England established to raise revenues for their governments, particularly for fighting wars?

The headline is certainly a hoot, given how far the actually existing Austrian economy is from what Austrian economists would recommend it be, although it is in fact one of the better performing economies in the world.

Well, the headline is only about eighty years late.

Steve, Just happened to notice your letter. I hate to take issue with you (especially after you sided with me about central banking and central planning), but I am afraid that Gregory Ip is closer to being right than you think. If you go back and read Monetary Theory and the Trade Cycle, you will see that Hayek works out a model in which the cycle is purely endogenous based on the Wicksellian assumption that the (unobservable) natural rate of interest changes causing the market rate to diverge from the natural rate. (I am writing this from memory, so I haven't checked to see if that is the mechanism that he adopts to generate a cycle, but he is absolutely explicit that the cycle is endogenous once there is a disturbance causing the natural rate to change.) I don't think that Mises would have denied that there is an endogenous cycle either given that the natural rate is unobservable and fluctuates. He just claimed that central banks are generally biased toward inflation exacerbating the inherent cyclical tendency. I think the most you could argue would be that in the absence of central bank misbehavior, Mises and Hayek would have argued that cycles not have been nearly as pronounced as they were in fact.

David,

Yes, Hayek does discuss the case where the natural rate changes without a matching movement in the market rate, but then the question is why the market rate doesn't change to match it. One could argue that this is a failure of monetary institutions and that, if monetary institutions are truly market-driven, such a scenario would be far less likely, if not impossible. Central banks can cause cycles by sins of commission and omission.

Beyond that, the language of "natural feature" plays right into the idea that Austrians don't have any ideas about how to, as you say, make institutional changes that would at least dramatically reduce such cycles, if not eliminate them. Yes, in terms of narrow economic theory, you may have a point, but in the broader rhetorical context of Ip's piece, connected up with the whole "liquidationist" nonsense, it was important to point out that the *dominant* Austrian view is that in *most* cases, the cycle is triggered by central bank action or failure to act when it should, rather than being an "inherent" feature of markets that we just have to learn to live with.

Doug Rasmussen and I wrote a paper on the issue raised by David Glassner, and it is online at RAE. Hayek did believe that the natural rate changes due to real factors. (Who could not believe that?) Nonetheless, his theory is that monetary policy is the cuase of the cycle.

Obviously, the "natural rate" (the "real" equilibrium rate towards which the market would be gravitating) is subject to change -- changes in time preferences, anticipated profitabilities from undertaking various investments, the available savings on the basis of which capital may be maintained and increased, etc.).

The issue is precisely why the "money rate" would fail to move in directions tending toward whatever the underlying "natural" rate is, at which the plans of savers would be coordinated with the plans of borrowers -- both in terms of the amounts and time horizons of investment projects.

Hayek in "Monetary Theory and the Trade Cycle," Fritz Machlup in "The Stock Market, Credit, and Capital Formation," and Mises in "Human Action" all accepted the idea that the natural rate shifts but the money rate may fail to reflect the underlying factors at work in such intertemporal exchange decisions.

And, thus, a discrepancy emerges between the two, just as if the natural rate had remained unchanged and the money rate was modified.

It is worth recalling that in the Wicksellian model -- which is the starting framework for the Austrian theory of money and the business cycle -- the money rate can be both "below" or "above" the hypothetical "natural rate." And this can generate "cumulative processes" that, in principle, can be price inflationary and price deflationary.

And within any resulting change in the general scale of prices there will be an inseparable and inescapable modification in the structures of relative prices, wages, and production.

But in the current situation, it seems to me, we have no idea what money or market rates of interest should or would be (in terms of that tendency to reflect an underlying "natural rate").

This is due to the fact that the Federal Reserve is actively keeping key rates of interest, most easily "influenced" by Fed policy, at near zero nominal levels -- and even "negative" when adjusted for CPI benchmarks for price inflation.

So what should be market rates of interest to reflect the "real" costs of capital, the actual availability of savings relative to demands to borrow?

"Out there" is a hypothetical "natural rate" reflecting the underlying "real" resource availabilities, and time valuations of savers and borrowers. But we have no market-based information about what it is precisely because the Federal Reserve is preventing the price system -- in this case intertemporal prices on the loan markets -- from functioning, that is, from "telling the truth," even if through "a glass darkly" given the nature of financial intermediation today under central banking.

Richard Ebeling

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