Keynesian Theory Of Interest

[nimble]

I have been reading Keynes's General Theory, because I thought it was a must read, if I am ever to be taken serious in the academic world as an economist. Plus it helps if I ever need to debate the book, it can't hurt to read it. Anyway to my point, after reading it, I have to agree that alot of his criticisms of classical theory are very true, which makes me think he was a slightly better economist than I gave him credit for. However, I think he errs in assuming that government can solve alot of the problems he finds. Anyway, the most interesting thing I learned from the book was that classical theory of interest rates seems to be horribly wrong. That an increase in the rate of interest does not necessarily mean that people will save more. He claims that classical economists isolate too many factors. If the rate of interest increases it also means that the marginal rate of capital efficiency goes up (meaning capital is not as efficient, and that entreprenuers will be less likely to borrow and direct production). This means that employment will fall, which means average income will fall, and people will be less likely to save because they don't have the spare money. There is alot more, but if anyone would like to discuss the book, I'd like to talk it over with an intelligent person.

[BlackSabbath]

Read 'The Failure of the New Economics' by Henry Hazlitt. Hazlitt read the entire book and could not find one statement that was both true and original. What was original was not true and what was true was not original.

[Inspector]

Hazlitt read the entire book and could not find one statement that was both true and original. What was original was not true and what was true was not original.

Wow! Are those his words or yours? Kudos on the wit of whoever wrote that!

Edited July 28, 2005 by Inspector

[BlackSabbath]

Wow! Are those his words or yours? Kudos on the wit of whoever wrote that!

Those are the words of Henry Hazlitt.

[nimble]

I don't doubt that parts aren't "original," economics is the study of rational human action. Most of economic theory is just rehashed things applied to different areas. Economics is merely observation of human actions, so if two people witness the same behavior, which they should, then they should come to the same conclusion. But that isn't the point. The book does make many errors, specifically about the role of government in an economy. But the point I raised was has any one read it, and what did they think about it's critique of classical theory of interest.

[BurgessLau]

[...] economics is the study of rational human action. [...] Economics is merely observation of human actions [...]

Which is it? Is economics "the study of rational human action" or is it "merely observation of human actions"? (Italics added) And why do you specify rational human action in one case but not in the other? I am very confused.

My confusion grows when I remember that historians, sociologists, and others study human action too. Are they really economists?

At the end of your first post, you said (in reference to another subject): "... I'd like to talk it over with an intelligent person." I will feel honored if you deign to answer my questions.

[BlackSabbath]

I don't doubt that parts aren't "original," economics is the study of rational human action. Most of economic theory is just rehashed things applied to different areas. Economics is merely observation of human actions, so if two people witness the same behavior, which they should, then they should come to the same conclusion. But that isn't the point. The book does make many errors, specifically about the role of government in an economy. But the point I raised was has any one read it, and what did they think about it's critique of classical theory of interest.

Not read it but I'm sure that Henry Hazlitt deals with it. Given his track record, Keynes is probably about as wrong as wrong gets, outside of marxism.

[nimble]

Which is it? Is economics "the study of rational human action" or is it "merely observation of human actions"? (Italics added) And why do you specify rational human action in one case but not in the other? I am very confused.

My confusion grows when I remember that historians, sociologists, and others study human action too. Are they really economists?

At the end of your first post, you said (in reference to another subject): "... I'd like to talk it over with an intelligent person." I will feel honored if you deign to answer my questions.

Human actions are rational actions, at least on the margin. Most economists are historians in a sense, and sociologists. Now as far as neo-classical economists go, they tend to be more math oriented, while they try to predict future markets and such, however, it is my and the austrian belief that markets are not entirely unpredictable, but that they are not specifically predictable simply because humans have free will. I don't think any math equations will ever "figure out" what each individual will do to create a specific predicted action.

I don't get the last part of your post, I wasn't being condescending...I was just under the assumption that most people in this forum are well read in economics, and are intelligent, so I thought this forum would be a good place to discuss the book. Anyway, if you would like to discuss theories of interest, then I would feel honored if you deign to reply.

[nimble]

Not read it but I'm sure that Henry Hazlitt deals with it. Given his track record, Keynes is probably about as wrong as wrong gets, outside of marxism.

The thing with Keynes is, he said a lot that makes sense and was a generally smart guy, but he wasn't much of a philosopher and a lot of his statements pushed toward a less free economy. His biggest problem was that he was too influenced by G. E. Moore.

[BlackSabbath]

The thing with Keynes is, he said a lot that makes sense and was a generally smart guy, but he wasn't much of a philosopher and a lot of his statements pushed toward a less free economy. His biggest problem was that he was too influenced by G. E. Moore.

Having read Hazlitt - who wades through the book point-by-point using liberal quotations - I find that Keynes was a half-wit who couldn't write for toffee and helped to revive the old mercantilist fallacies refuted by Adam Smith and his contemporaries.

[nimble]

Having read Hazlitt - who wades through the book point-by-point using liberal quotations - I find that Keynes was a half-wit who couldn't write for toffee and helped to revive the old mercantilist fallacies refuted by Adam Smith and his contemporaries.

You are right about his lack of ability to write. That book had to be the single hardest book to comprehend, even though it rarely dealt with difficult concepts. I found myself rereading several paragraphs just to understand what he was saying. He uses way to many commas.

[JMeganSnow]

I apologize if this is a hugely stupid question, but is the rate of interest you get on money you save in the bank necessarily directly connected to the rate they get from people the bank lends money to? I would think they'd try to set their rates of interest at a point where they can attract customers but still make a profit. So I suppose the question becomes, does bank profit come entirely (or even mostly) from interest on loans?

If your bank has other sorts of investments, is the rate-of-return always determined by interest rates?

If it's not the case that the rate of interest-on-savings is necessarily tied to the rate interest-on-loans then Keynes' entire theory falls to bits, because a rise in interest-on-savings doesn't necessarily mean there will be a corresponding rise in interest-on-loans, i.e. interest-on-capital, which would mean that the "marginal rate of capital efficiency" may or may NOT decrease, meaning that the whole cause-and-effect chain would collapse.

Pardon me if I've committed a laughable error, I don't know a WHOLE lot about economics.

[nimble]

I apologize if this is a hugely stupid question, but is the rate of interest you get on money you save in the bank necessarily directly connected to the rate they get from people the bank lends money to?  I would think they'd try to set their rates of interest at a point where they can attract customers but still make a profit.  So I suppose the question becomes, does bank profit come entirely (or even mostly) from interest on loans? 

It's okay, that isn't a stupid question. The rate of interest is very complex. It is determined by many factors such as how long you borrow/lend, how good your credit rating is (risk), and a few other factors. Banks always lend at a higher rate of interest than they borrow, and that does account for its profits, so you are right there. The main reason you get such a lower interest rate when you give your money to the bank rather than when you borrow from the bank is because most people are short term savers, but long term borrowers. Because you don't usually keep your money in the bank for long when saving, the bank gives you a low rate of interest because short term interest rates are always much lower than long term ones. And when banks make loans, they are usually long term loans, which need a higher interest rate.

If your bank has other sorts of investments, is the rate-of-return always determined by interest rates? 

Yes, the bank won't give you more money simply because it happened to make more money off the investment than it intended. Whatever interest rate you agreed to in the beginning when you gave the bank your money, thats what you will get. So I think you are understanding it.

If it's not the case that the rate of interest-on-savings is necessarily tied to the rate interest-on-loans then Keynes' entire theory falls to bits, because a rise in interest-on-savings doesn't necessarily mean there will be a corresponding rise in interest-on-loans, i.e. interest-on-capital, which would mean that the "marginal rate of capital efficiency" may or may NOT decrease, meaning that the whole cause-and-effect chain would collapse.

This is where you make a little mistake, but its probably just because you haven't studied economics before. In macro-economics, the banks are counted on the savings side of the interest rate calculations, and the businesses that buy new capital equipment (machines, raw material, etc) are on the investment side, and where the supply of savings meets the demand of investment is what the interest rate will be. So when Keynes mentions savings in general, he includes banks and their interest rate discrepancies. But, I like that you took the time to figure all that out without knowing that much about econ, that is very impressive.

Pardon me if I've committed a laughable error, I don't know a WHOLE lot about economics.

I don't think there are laughable errors. I don't like arrogance, and I think anyone who is seeking the truth should not be laughed at.

[softwareNerd]

... is the rate of interest you get on money you save in the bank necessarily directly connected to the rate they get from people the bank lends money to?

The rate paid by the the bank on its borrowings is one of its costs. The rate it gets paid on its lendings are one of its revenues. The relationship is thus similar to that between any other major business cost and the price the business must charge its customers.

...does bank profit come entirely (or even mostly) from interest on loans?

The other income source for banks is "fee income" (trust income, brokerage fees, investment banking fees, etc.). For most traditional retail banks, interest income (i.e. interest received minus interest paid) is the largest component of their income.

[softwareNerd]

... classical theory of interest rates seems to be horribly wrong. ... [according to Keynes] If the rate of interest increases it also means that the marginal rate of capital efficiency goes up ... There is alot more, but if anyone would like to discuss the book, I'd like to talk it over with an intelligent person.

Nimble, I suggest that for this thread we ignore the classical theory, and assume it to be false, for the sake of argument. Having done that, how is the following question answered in the Keynesian model: How are interest rates determined in an economy?

What are the steps in the Keynesian model? Or, alternatively, in the model you think is right?

[nimble]

Nimble, I suggest that for this thread we ignore the classical theory, and assume it to be false, for the sake of argument. Having done that, how is the following question answered in the Keynesian model: How are interest rates determined in an economy?

What are the steps in the Keynesian model? Or, alternatively, in the model you think is right?

Keynes claims that interest rates are cyclical, which I guess means that he believes that there is no beginning or end to an interest rate. His book is horribly muddled and poorly worded, but from what I can decifer, he believes interest rates are determined by entrepreneurs expectations of demand (investment), which has to do with the level of consumers' income and employment, and that the level of income and employment will determine how much people can save (savings) and where the savings supply and investment demand meet is where the interest rate will be. He also states that interest rates will always be less than or equal to the marginal efficiency of capital. Basically, interest rates will equal how much more output per extra unit of capital that is bought as investment for a business. Example, if I can make 6% more money by purchasing a new factory, than I would not borrow at a rate of interest any higher than 6%, or else I could have just gotten more money by putting my money into the money market rather than building a factory.

*Please note: I am not defending Keynes, I am an Austrian Economist, so I obviously differ greatly with him, but I just wanted to discuss the ideas I read in his book.

[nimble]

What are the steps in the Keynesian model? Or, alternatively, in the model you think is right?

I don't know what I think is right as of the moment, I believed the classical model to be the correct one, until I read General Theory. I still don't like Keynes in general, but he kind of made me question classical theory. So that is the reason I wanted to discuss this issue with someone.

Edited July 29, 2005 by nimble

[jrs]

I have read Keynes' book, but it was so many years ago that I do not quite remember what it said. But I think that he ignores the quantity of money in private hands and assumes that consumption and saving are only functions of income.

...  I have to agree that alot of his criticisms of classical theory are very true, ...

...  classical theory of interest rates seems to be horribly wrong.

Please state clearly those criticisms of the classical theory with which you agree.

If the rate of interest increases ...  employment will fall, which means average income will fall, and people will be less likely to save because they don't have the spare money.

Or perhaps they will save more because they have become afraid and so they reduce their expenditures by more than their income has been reduced.

That book had to be the single hardest book to comprehend, even though it rarely dealt with difficult concepts.

Making his book hard to understand also makes it hard for you to find his errors. Many people mistake obscurity for profundity.

[BlackSabbath]

You are right about his lack of ability to write. That book had to be the single hardest book to comprehend, even though it rarely dealt with difficult concepts. I found myself rereading several paragraphs just to understand what he was saying.

That's not without significance. Kant and Hegel are virtually impenetrable while Rand and Peikoff are excellent and dead easy to read.

Marx is virtually unreadable, so much so that many marxists have never read him, while Mises, Hazlitt, Salsman and Reisman, the last two being a wonderful combination of Objectivism and economics, are very clear and concise.

It's almost as if the 'baddies' need to obscure their evil ideas as much as possible.

[AisA]

Human actions are rational actions, at least on the margin.

What do you mean by "on the margin"? Are you saying that some class of human action is inherently rational?

[Alan Forrester]

What do you mean by "on the margin"? Are you saying that some class of human action is inherently rational?

In economics rational action simply means that each individual action is self-consistent. So a bricklayer will not attempt to simultaneously put concrete on a brick and remove it. However, people can change their ideas. The bricklayer may decide after putting concrete on a brick that he ought to take it off for some reason. And of course people may misunderstand the world and hold two mutually inconsistent theories which happen to prompt him to take the same action in a particular situation. For example, a man might be a socialist and believe that individuals ought to be free to do what they want as long as he doesn't examine both beliefs in detail at the same time. This might lead him to help an old woman across the road and think of this as his individual choice to help her as well as thinking that he is being a good socialist an helping a poor person. Of course this man would be a bit stupid, but lots of people are a bit stupid.

[DavidOdden]

In economics rational action simply means that each individual action is self-consistent.

What does that mean? If that means "consistent with a particular purpose", then that would be sensible. If your goal is to live long and prosper, then consistently acting in a self-destructive manner would not be rational, though it would be consistent. I don't see how it can mean anything for one action to be "consistent with" another action, only a goal.

[Alan Forrester]

What does that mean? If that means "consistent with a particular purpose", then that would be sensible. If your goal is to live long and prosper, then consistently acting in a self-destructive manner would not be rational, though it would be consistent. I don't see how it can mean anything for one action to be "consistent with" another action, only a goal.

Yes, it means consistent with a particular purpose and that purpose may be wrongheaded. And people use the word rationality to denote lots of different ideas. If you want to use a different term then come up with one.