November 18, 2015

How economic thinkers think they think about interest

Comment on ‘Thinking about Interest and Irving Fisher’


“Everything can be ‘explained’ if we place no restrictions on what we mean by ‘explanation’.” (Blaug, 1994, p. 123)

David Glasner renders an exhaustive exegesis of the current state of the theory of interest. These are the highlights.

Keynes: “Unfortunately, Keynes imagined that by identifying and explaining the liquidity premium on cash, he had thereby explained the real yield on holding physical capital assets; he did nothing of the kind, ...” (See intro)

Marshall: “the... classical theory of interest, ... in which the rate of interest is supposed to be the rate that equilibrates saving and investment.”

Fisher: “I [Glasner] doubt that ... he ever asserted that the rate of interest is determined by equilibrating savings and investment.”

Wicksell: “Maybe it was Knut Wicksell who in his discussions of the determination of the rate of interest argued that the rate of interest is responsible for equalizing savings and investment, but that was not how Fisher understood what the rate of interest is all about.”

Robertson: “This mistaken doctrine was formalized as the loanable-funds theory of interest ... in which savings is represented as the supply of loanable funds and investment is represented as the demand for loanable funds, with the rate of interest serving as a sort of price that is determined in Marshallian fashion by the intersection of the two schedules.”

Glasner: “Why do I say that the loanable-funds theory is mistaken and incoherent? Simply because it is fundamentally inconsistent with the essential properties of general-equilibrium analysis. In general-equilibrium analysis, interest rates emerge not as a separate subset of prices determined in a corresponding subset of markets; they emerge from the intertemporal relationships between and across all asset markets and asset prices.”

Rowe: “... there is no single market in which the exchange value of money (medium of account) is determined, because money is exchanged for goods in all markets, there can be no single market in which the rate of interest is determined because the value of every asset depends on the rate of interest at which the expected income or service-flow derived from the asset is discounted.”

Conclusion: “The determination of the rate of interest can’t be confined to a single market.” (See intro) In other words, everything depends on everything else, in fact no price is determined in a single market, the economy is very complex and consists of stocks and flows, the future is uncertain, and, as Keynes always said: “We simply do not know.”

However, the determination of the many nominal and real interest rates can be referred to General Equilibrium Theory because “my cousin Abraham Wald and subsequently ... Arrow, Debreu and McKenzie showed that Fisher’s claim could, under some more or less plausible assumptions, be proved in a mathematically rigorous way.”

It seems that the news got lost on David Glasner that General Equilibrium Theory is dead and buried since Sonnenschein/Mantel/Debreu (Ackerman et al., 2004).

Because both — the Walrasian and the Keynesian — approaches are fundamentally (=axiomatically) flawed the theory of interest is flawed by logical implication. In order to develop the theory of interest from scratch (2011) one has — first of all — to refer Marshall, Keynes, Wicksell, Sraffa, Robertson, Fisher, Rowe, Glasner and some others from the set of scientific thinkers to the complementary set of confused confusers (2013).

Egmont Kakarot-Handtke

Ackerman, F., and Nadal, A. (Eds.) (2004). Still Dead After All These Years: Interpreting the Failure of General Equilibrium Theory. London, New York, NY: Routledge.
Blaug, M. (1994). Why I am Not a Constructivist. Confessions of an Unrepetant Popperian. In R. E. Backhouse (Ed.), New Directions in Economic Methodology, pages 109–136. London, New York, NY: Routledge.
Kakarot-Handtke, E. (2011). Reconstructing the Quantity Theory (I). SSRN Working Paper Series, 1895268: 1–28. URL
Kakarot-Handtke, E. (2013). Confused Confusers: How to Stop Thinking Like an Economist and Start Thinking Like a Scientist. SSRN Working Paper Series, 2207598: 1–16. URL

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