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Interest Rates and the Keynesian Myth

Interest-Rates / US Economy Apr 08, 2008 - 02:55 PM GMT

By: Gerard_Jackson

Interest-Rates Still lurking in the Keynesian woodshed is the myth that interest is a monetary phenomenon that is artificially keeping capital scarce. Eliminate interest and presto! Capital will become superabundant. Keynes repeated this preposterous fallacy in the Paper of the British Experts , 8 April 1943, in which he asserted that "Credit expansion performs the miracle . . . of turning stone into bread".

So why was it that stone had not already been turned into bread? The answer, according to Keynes, is that rentiers and capitalists deliberately created scarcity in order to exploit consumers. This is no distortion of Keynes' views. On page 376 of The General Theory (MacMillan St. Martin's Press, Royal Economic Society edition, 1973) he said that "there are no intrinsic reasons for the scarcity of capital". This is a truly amazing statement for a so-called economist to make.

On pages 575-576 he calls for "the euthanasia of the rentier, and, consequently, the cumulative power of the capitalist to exploit the scarcity-value of capital". No wonder so many Keynesians are lefties. But what about savings and investment? That, so claimed Keynes, could be safely left in the hands of the state: meaning omniscient bureaucrats and, as Adam Smith scathingly put it:

. . . that insidious and crafty animal, vulgarly called a statesman or politician, whose counsels are directed by the momentary fluctuation of affairs. ( The Wealth of Nations , LibertyClassics, Vol. I, 1978, p. 468).

Missing from The General Theory is any genuine understanding of the nature of interest and therefore any meaningful discussion of the dire economic consequences of central banks manipulating interest rates. Ludwig von Mises exposed the shallowness and dangers of Keynes' thinking when he wrote:

It regards interest as compensation for the temporary relinquishing of money in the broader sense. A view, indeed, of unsurpassable naivet?Scientific critics have been perfectly justified in treating it with contempt. (Ludwig von Mises, The Theory of Money and Credit , The Foundation for Economic Education, Inc. 1971, p. 353).

He went on to say that such views "are continually being propounded afresh. . . ." (Ibid . 353). And this was written 24 years before the The General Theory was published. Keynes' response was to falsely claim that "Professor von Mises and his disciples have got their conclusions exactly the wrong way round" (GT. pp. 192-93). If Keynes had bothered to study the subject properly it would have become clear that the marginal efficiency of capital is the rate of interest. This is the natural rate of interest and a price on the time market.

Despite claims to originality by his disciples Keynes' theory of interest is one of the oldest economic fallacies around. It would have been far better for the world if he had studied Richard Cantillon's brilliant analysis of the microeconomic effects of expanding the money supply. ( Essay on the Nature of Commerce in General , Transaction Publishers, 2001, written about 1734 and first published in 1752). Cantillon also nailed Keynes on interest rate determination with the observation:

Just as the Prices of things are fixed in the altercations of the Market by the quantity of things offered for sale in proportion to the quantity of money offered for them, or, what comes to the same thing, by the proportionate number of Sellers and Buyers, so in the same way Interest of Money in a State is settled by the proportionate number of Lenders and Borrowers (ibid. p. 82).

The rest of the chapter makes Keynes look like a rank amateur, as the following quote from the General Theory makes clear:

Pyramid-building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of classical economics stands in the way of anything better. (p.129).

It is truly astonishing that any man who could seriously write this rubbish could be taken as a great economist. Nevertheless, it was enthusiastically taken on board by Paul Samuelson who proclaimed:

There is nothing special about government spending on jet bombers and intercontinental ballistic missiles that leads to a larger multiplier support of the economy than would other kinds of government expenditure. ( Economics , Seventh Edition, New York: McGraw, 1967).

Truth be told, if our so-called statesmen had adhered to classical principles the world not only be in a far better economic state it would not have had to bear the burden of publishing Samuelson's text book and his outlandish claim about the mythical multiplier.

Ideas have consequences — specially bad ideas. Keynesian policies have attacked savings, reduced the rate of investment, created balance-of-payments problems, produced recurring international financial crises, given us permanent inflation, and provided grasping ignorant politicians with the rationale to levy heavy tax rates and continually try to raise government spending.

By Gerard Jackson

Gerard Jackson is Brookes' economics editor.

Copyright © 2008 Gerard Jackson

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