Lesson 2 of 8
Sraffa, and which natural rate
In a world of many goods there is no single natural rate of interest, only one per commodity. If so, the theory's central instruction has no referent.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
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In one minute
- Sraffa's review argued that outside a stationary state there are as many own-rates of interest as there are commodities, and none of them is the natural rate.
- The objection is not that the rate is hard to measure. It is that the concept the theory builds on may have no unique referent in a changing economy.
- A modern writer inside the tradition accepts the objection against the standard exposition and proposes replacing the underlying equilibrium construct rather than defending it.
Piero Sraffa reviewed Hayek's Prices and Production in the Economic Journal in 1932. Hayek replied in the same volume and Sraffa published a rejoinder. One part of that exchange has outlived the rest, and it goes at the foundation rather than at the mechanism.
Own rates of interest in a two-good economy
Reckoned in apples
- A frost is expected to reduce next year's oranges.
- Apples today buy more apples next year.
- The own rate on apples is positive.
- Lending in apples earns a real return.
Reckoned in oranges
- The same frost makes oranges scarcer later.
- Oranges today buy fewer oranges next year.
- The own rate on oranges is negative.
- Lending in oranges loses in real terms.
There is no contradiction between the rows. There is simply no single number they agree on.
The objection as Sraffa made it
The theory Hayek was defending says that a boom begins when the money rate of interest is pushed below the natural rate: the rate that would prevail if saving and investment met directly rather than through banks that can create credit.
Sraffa's review attacks the assumption that such a rate is well defined. In a barter economy where loans could be made in any commodity, he argues, there is a single rate only in equilibrium; at any moment outside it there are as many natural rates as there are commodities, each the rate at which a unit of that good today exchanges for units of the same good later. He grants that a rate can be defined against a chosen basket, and points out that the basket is arbitrary: choose a different one and you get a different rate.
If that is right, the instruction at the centre of the theory is incomplete. Below which natural rate, and measured in what.
Where the argument stands now
This is one of the two lessons in this course where the original could not be obtained. Sraffa's review, Hayek's reply and Sraffa's rejoinder are all real, all in volume 42 of the Economic Journal for 1932, and this course read Sraffa's argument in the passages reproduced and cited by a later writer rather than in the journal itself. That is said here rather than hidden.
The later writer is Robert Murphy, an economist working inside the tradition, whose paper accepts the objection against the standard exposition and calls it a serious problem rather than a misunderstanding. His proposal is to stop defining the natural rate against a stationary construct in which nothing changes, and to define it instead against a dynamic equilibrium in which conditions change but are correctly anticipated. In that setting the boom is still a divergence, but the thing it diverges from is a structure of rates rather than one number.
Whether that repair works is not something this course can settle. What it shows is that the objection is taken seriously by people who hold the theory, which is a better indication of its force than anything a critic could say.
Why this matters beyond the history
The reason to teach this early is that it changes how you read every later claim in the track. A statement that the rate was too low invites the question that Sraffa asked: too low against what, and would the answer be the same if a different basket had been chosen.
That is a discipline a reader can apply immediately, without taking a side on whether the theory survives it.
Check yourself
What did Sraffa argue about the natural rate?
- That it is always lower than the money rate
- That outside a stationary state there are as many own rates as there are commodities, and no unique natural rate
- That central banks cannot observe it
Show the answer
Answer: B.
The claim is about the concept rather than about measurement: with loans possible in any commodity, each commodity has its own rate and none is privileged.What does defining a rate against a basket of goods achieve?
- It removes the problem entirely
- It produces a unique rate for that basket, at the cost of the basket being an arbitrary choice
- It makes the rate observable in the bond market
Show the answer
Answer: B.
Sraffa grants that a rate exists once a composite commodity is fixed, and objects that the composite is not unique, so neither is the rate.How does the modern repair described here respond?
- By denying that own rates differ
- By replacing the stationary equilibrium construct with a dynamic one in which anticipated change is allowed
- By treating the objection as a misunderstanding of capital theory
Show the answer
Answer: B.
Murphy's paper accepts the objection against the canonical exposition and argues the theory should be restated against a dynamic equilibrium instead.Sources
- Sraffa, 'Dr. Hayek on Money and Capital', The Economic Journal, volume 42, 1932: the argument that there may be as many natural rates as there are commodities outside equilibrium, and that a rate defined against a composite commodity depends on which composite is chosen. Hayek's reply and Sraffa's rejoinder appear in the following issue of the same volume.
- Murphy, 'Multiple Interest Rates and Austrian Business Cycle Theory', a Mises Institute working paper, section two: the reproduction of Sraffa's argument with its page references, the two-good worked example, and the proposal to restate the theory against a dynamic equilibrium.
What this leaves out
- This is a heterodox tradition. The mainstream account of the same phenomenon differs, and nothing here is a forecast or a view on any security.
- Sraffa's review itself was not obtained for this lesson. His argument is reported from passages reproduced with page citations in Murphy's paper, and Hayek's reply was not read at all, so nothing is claimed here about how Hayek answered.
- The apples and oranges figure follows the structure of the example in Murphy's paper. It is an illustration of a concept and describes no market.
- Murphy's paper carries no publication date on the copy consulted, so none is stated.