Sunday, June 22, 2008

Confused As Ever: The Theory of Interest

Continuing along with the Mengerian theme, I just finished reading his chapter on the theory of value. I must say that it is a supurb analysis, though dense at times, but an altogether essential passage for aspiring economists. My one problem originates from his brief references to the interest phenomena and its requisite causes. Menger echoes the views of the 20th century American economist F.H. Knight as he writes "Some economists represent the payment of interest as a reimbursement for the abstinence of the owner of capital. Against this doctrice, I must point out that the abstinence of a person cannot, by itself, attain goods-character and thus value." (p.156) and later on pages 158-59 and 172-74 Menger emphasizes interest as a type of price for the services of capital.

This view seems to be at odds with what I have already found in the writings of Ludwig von Mises, among other more recent Austrian economists. Mises writes that the interest phenomena originates from intertemporal preferences, ie. people prefer present consumption to some future consumption, and in order to forgo present consumption there must be some higher consumption possibility in the future. The interest rate, according to Mises, reflects the price at which it takes the marginal person to forgo present consumption in favor of consumption in some far-off future period. And off of this formulation of the interest concept Mises concocted the famous Austrian theory of the trade cycle. So if Mises' theory is the less acceptable version, then this could have far reaching effects on my views of a whole host of very important concepts (Hayek's work on the trade cycle, the idea that capital is heterogenous and not, as F.H. Knight and J.B. Clark argued, a homogeneous fund).

Perhaps this incongruity in Menger and Mises views on interest merely reflects the fact that Menger was writing a pioneering work, and like every work that blazes a newly divergent intellectual trail, there is likely to be some errors or misconceptions, which then need to be reformulated and expounded upon by future scholars. Regardless, what this discovery means for me is that I now must investigate F.H. Knight's conception of capital theory and all its attendent implications for the interest phenomena and the structure of production in a capitalistic economy. I hear Milton Friedman's conception of capital ran along the same lines as Knight, so it's not a completely bogus viewpoint.

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