Keynes - The General Theory - Chapter XVII

In this chapter, Keynes examines some of "the essential properties of interest and money."

Section I: Continuing from the last chapter, Keynes postulates that: "the rate of interest on money plays a peculiar part in setting a limit to the level of employment." We must ascertain why this is the case.

In order to do so, in addition to the rate of interest for money, he introduces a rate of interest for every asset in the economy: "for every durable commodity we have a rate of interest in terms of itself, — a wheat-rate of interest, a copper-rate of interest, a house-rate of interest, even a steel-plant-rate of interest." He "proves" this by using an example; if the rate of interest is x and wheat pays x + a during the same time period, the wheat rate of interest is a.

It's puzzling as to why anyone could have maintained this theory. Part of the confusion, no doubt, stems from Keynes's failure to give the reason why the rate of interest exists. It emerges because of human time preference: we all prefer the same amount of a good sooner rather than later; in order to compel someone to give up usage of a good, he must be offered something in exchange. So if I want to borrow 100 dollars, I must promise to pay 105 dollars one year hence--if five dollars per year is the rate of interest. But the rate of interest, though paid in money, is not a characteristic of money; it is a direct result of time preference. Interest is commonly paid in money for the same reason wages are paid in money.

Now, in the futures market, like any other market, deals are made based on expected future prices. The so-called wheat rate of interest, then, is simply an anticipation of a rise or decline in wheat prices. It is not a rate of interest at all.

Section II: Building on this nonsense, Keynes seeks to use one rate of interest to calculate other rates of interest in the economy. This turns out to be easy: "To determine the relationships between the expected returns on different types of assets which are consistent with equilibrium, we must also know what the changes in relative values during the year are expected to be."

Did I say easy? I meant impossible, seeing that future prices cannot be calculated with any certainty. It is characteristic of Keynes that, instead of confronting the epistemological conundrum, he utilizes algebra to give mock precision to the unfathomable. This is either perniciousness or idiocy. I pass over regardless.

Section III: We have here some more fallacies about rates of interest. I'm afraid this chapter adds little to our understanding, not only of economics--for this is a reoccurring theme--but even with the Keynesian flavor. For instance, Keynes seems to think that the reason that the money rate of interest is significant--there is really only one rate of interest--is because money "cannot be readily produced." On the contrary, argues Ben Bernanke of the magical printing press.

Section IV: Keynes discusses the stickiness of wages in terms of money--as opposed to other commodities. This is a bit of a misnomer. Wages may be relatively sticky if the money supply remains constant, but a change in the supply of money will alter the stickiness of wages--barring legislation which enforces it. In short, the laws of supply and demand apply to all goods in the economy, money included. And, of course, there is nothing to prevent contracts from being drawn up for payment in any commodity--say, beer. People tend to use money because it is easier to exchange than beer. But we may yet see a return to exchanges in precious metals.

Section V: I find only one observation worthy of comment:

"That the world after several millennia of steady individual saving, is so poor as it is in accumulated capital-assets, is to be explained, in my opinion, neither by the improvident propensities of mankind, nor even by the destruction of war, but by the high liquidity-premiums formerly attaching to the ownership of land and now attaching to money."

That Keynes could really believe that the world had gotten poorer, and that this was somehow due to saving, testifies to the feebleness of his mind.

Section VI: He abandons his previous conception of a natural rate of interest, which, because it can comprise merely to the particular level of employment--in equilibrium, of course--offers us no edification. In its stead, he postulates a neutral or optimum rate of interest, which is that at which full employment is attained. Keynes does not tell us what the wage rates of the various employees will be, a telling omission, as we could surely create full employment quite easily if wages were allowed to fall far enough.