everything old is better than everything new

“Monetary Policy in a Changing World”

While looking for something else, I came across this 1956 article on monetary policy by Erwin Miller. It’s a fascinating read, especially in light of current discussions about, well, monetary policy in a changing world. Reading the article was yet another reminder that, in many ways, debates about central banking were more sophisticated and far-reaching in the 1950s than they are today.

The recent discussions have been focused mainly on what the goals or targets of monetary policy should be. While the rethinking there is welcome — higher wages are not a reliable sign of rising inflation; there are good reasons to accept above-target inflation, if it developed — the tool the Fed is supposed to be using to hit these targets is the overnight interest rate faced by banks, just as it’s been for decades. The mechanism by which this tool works is basically taken for granted — economy-wide interest rates move with the rate set by the Fed, and economic activity reliably responds to changes in these interest rates. If this tool has been ineffective recently, that’s just about the special conditions of the zero lower bound. Still largely off limits are the ideas that, when effective, monetary policy affects income distribution and the composition of output and not just its level, and that, to be effective, monetary policy must actively direct the flow of credit within the economy and not just control the overall level of liquidity.

Miller is asking a more fundamental question: What are the institutional requirements for monetary policy to be effective at all? His answer is that conventional monetary policy makes sense in a world of competitive small businesses and small government, but that different tools are called for in a world of large corporations and where the public sector accounts for a substantial part of economic activity. It’s striking that the assumptions he already thought were outmoded in the 1950s still guide most discussions of macroeconomic policy today.¹

From his point of view, relying on the interest rate as the main tool of macroeconomic management is just an unthinking holdover from the past — the “normal” world of the 1920s — without regard for the changed environment that would favor other approaches. It’s just the same today — with the one difference that you’ll no longer find these arguments in the Quarterly Journal of Economics.²

Rather than resort unimaginatively to traditional devices whose heyday was one with a far different institutional environment, authorities should seek newer solutions better in harmony with the current economic ‘facts of life.’ These newer solutions include, among others, real estate credit control, consumer credit control, and security reserve requirements…, all of which … restrain the volume of credit available in the private sector of the economy.

Miller has several criticisms of conventional monetary policy, or as he calls it, “flexible interest rate policies” — the implicit alternative being the wartime policy of holding key rates fixed. One straightforward criticism is that changing interest rates is itself a form of macroeconomic instability. Indeed, insofar as both interest rates and inflation describe the terms on which present goods trade for future goods, it’s not obvious why stable inflation should be a higher priority than stable interest rates.

A second, more practical problem is that to the extent that a large part of outstanding debt is owed by the public sector, the income effects of interest rate changes will become more important than the price effects. In a world of large public debts, conventional monetary policy will affect mainly the flow of interest payments on existing debt rather than new borrowing. Or as Miller puts it,

If government is compelled to borrow on a large scale for such reasons of social policy — i.e., if the expenditure programs are regarded as of such compelling social importance that they cannot be postponed merely for monetary considerations — then it would appear illogical to raise interest rates against government, the preponderant borrower, in order to restrict credit in the private sphere.

Arguably, this consideration applied more strongly in the 1950s, when government accounted for the majority of all debt outstanding; but even today governments (federal plus state and local) accounts for over a third of total US debt. And the same argument goes for many forms of private debt as well.

As a corollary to this argument — and my MMT friends will like this — Miller notes that a large fraction of federal debt is held by commercial banks, whose liabilities in turn serve as money. This two-step process is, in some sense, equivalent to simply having the government issue the money — except that the private banks get paid interest along the way. Why would inflation call for an increase in this subsidy?

Miller:

The continued existence of a large amount of that bank-held debt may be viewed as a sop to convention, a sophisticated device to issue needed money without appearing to do so. However, it is a device which requires that a subsidy (i.e., interest) be paid the banks to issue this money. It may therefore be argued that the government should redeem these bonds by an issue of paper money (or by an issue of debt to the central bank in exchange for deposit credit). … The upshot would be the removal of the governmental subsidy to banks for performing a function (i.e., creation of money) which constitutionally is the responsibility of the federal government.

Finance franchise, anyone?

This argument, I’m sorry to say, does not really work today — only a small fraction of federal debt is now owned by commercial banks, and there’s no longer a link, if there ever was, between their holdings of federal debt and the amount of money they create by lending. There are still good arguments for a public payments system, but they have to be made on other grounds.

The biggest argument against using a single interest rate as the main tool of macroeconomic management is that it doesn’t work very well. The interesting thing about this article is that Miller doesn’t spend much time on this point. He assumes his readers will already be skeptical:

There remains the question of the effectiveness of interest rates as a deterrent to potential private borrowing. The major arguments for each side of this issue are thoroughly familiar and surely demonstrate most serious doubt concerning that effectiveness.

Among other reasons, interest is a small part of overall cost for most business activity. And in any situation where macroeconomic stabilization is needed, it’s likely that expected returns will be moving for other reasons much faster than a change in interest rates can compensate for. Keynes says the same thing in the General Theory, though Miller doesn’t mention it.³ (Maybe in 1956 there wasn’t any need to.)

Because the direct link between interest rates and activity is so weak, Miller notes, more sophisticated defenders of the central bank’s stabilization role argue that it’s not so much a direct link between interest rates and activity as the effect of changes in the policy rate on banks’ lending decisions. These arguments “skillfully shift the points of emphasis … to show how even modest changes in interest rates can bring about significant credit control effects.”

Here Miller is responding to arguments made by a line of Fed-associated economists from his contemporary Robert Roosa through Ben Bernanke. The essence of these arguments is that the main effect of interest rate changes is not on the demand for credit but on the supply. Banks famously lend long and borrow short, so a bank’s lending decisions today must take into account financing conditions in the future. ⁴ A key piece of this argument — which makes it an improvement on orthodoxy, even if Miller is ultimately right to reject it — is that the effect of monetary policy can’t be reduced to a regular mathematical relationship, like the interest-output semi-elasticity of around 1 found in contemporary forecasting models. Rather, the effect of policy changes today depend on their effects on beliefs about policy tomorrow.

There’s a family resemblance here to modern ideas about forward guidance — though people like Roosa understood that managing market expectations was a trickier thing than just announcing a future policy. But even if one granted the effectiveness of this approach, an instrument that depends on changing beliefs about the long-term future is obviously unsuitable for managing transitory booms and busts.

A related point is that insofar as rising rates make it harder for banks to finance their existing positions, there is a chance this will create enough distress that the Fed will have to intervene — which will, of course, have the effect of making credit more available again. Once the focus shifts from the interest rate to credit conditions, there is no sharp line between the Fed’s monetary policy and lender of last resort roles.

A further criticism of conventional monetary policy is that it disproportionately impacts more interest-sensitive or liquidity-constrained sectors and units. Defenders of conventional monetary policy claim (or more often tacitly assume) that it affects all economic activity equally. The supposedly uniform effect of monetary policy is both supposed to make it an effective tool for macroeconomic management, and helps resolve the ideological tension between the need for such management and the belief in a self-regulating market economy. But of course the effect is not uniform. This is both because debtors and creditors are different, and because interest makes up a different share of the cost of different goods and services.

In particular, investment, especially investment in housing and other structures, is mo sensitive to interest and liquidity conditions than current production. Or as Miller puts it, “Interest rate flexibility uses instability of one variety to fight instability of a presumably more serious variety: the instability of the loanable funds price-level and of capital values is employed in an attempt to check commodity price-level and employment instability.” (emphasis added)

The point that interest rate changes, and monetary conditions generally, change the relative price of capital goods and consumption goods is important. Like much of Miller’s argument, it’s an unacknowledged borrowing from Keynes; more strikingly, it’s an anticipation of Minsky’s famous “two price” model, where the relative price of capital goods and current output is given a central role in explaining macroeconomic dynamics.

If we take a step back, of course, it’s obvious that some goods are more illiquid than others, and that liquidity conditions, or the availability of financing, will matter more for production of these goods than for the more immediately saleable ones. Which is one reason that it makes no sense to think that money is ever “neutral.”⁵

Miller continues:

In inflation, e.g., employment of interest rate flexibility would have as a consequence the spreading of windfall capital losses on security transactions, the impairment of capital values generally, the raising of interest costs of governmental units at all levels, the reduction in the liquidity of individuals and institutions in random fashion without regard for their underlying characteristics, the jeopardizing of the orderly completion of financing plans of nonfederal governmental units, and the spreading of fear and uncertainty generally.

Some businesses have large debts; when interest rates rise, their earnings fall relative to businesses that happen to have less debt. Some businesses depend on external finance for investment; when interest rates rise, their costs rise relative to businesses that are able to finance investment internally. In some industries, like residential construction, interest is a big part of overall costs; when interest rates rise, these industries will shrink relative to ones that don’t finance their current operations.

In all these ways, monetary policy is a form of central planning, redirecting activity from some units and sectors to other units and sectors. It’s just a concealed, and in large part for that reason crude and clumsy, form of planning.

Or as Miller puts it, conventional monetary policy

discriminates between those who have equity funds for purchases and those who must borrow to make similar purchases. … In so far as general restrictive action successfully reduces the volume of credit in use, some of those businesses and individuals dependent on bank credit are excluded from purchase marts, while no direct restraint is placed on those capable of financing themselves.

In an earlier era, Miller suggests, most borrowing was for business investment; most investment was externally financed; and business cycles were driven by fluctuations in investment. So there was a certain logic to focusing on interest rates as a tool of stabilization. Honestly, I’m not sure if that was ever true.But I certainly agree that by the 1950s — let alone today — it was not.

In a footnote, Miller offers a more compelling version of this story, attributing to the British economist R. S. Sayers the idea of

sensitive points in an economy. [Sayers] suggests that in the English economy mercantile credit in the middle decades of the nineteenth century and foreign lending in the later decades of that century were very sensitive spots and that the bank rate technique was particularly effective owing to its impact upon them. He then suggests that perhaps these sensitive points have given way to newer ones, namely, stock exchange speculation and consumer credit. Hence he concludes that central bank instruments should be employed which are designed to control these newer sensitive areas.

This, to me, is a remarkably sophisticated view of how we should think about monetary policy and credit conditions. It’s not an economywide increase or decrease in activity, which can be imagined as a representative household shifting their consumption over time; it’s a response of whatever specific sectors or activities are most dependent on credit markets, which will be different in different times and places. Which suggests that a useful education on monetary policy requires less calculus and more history and sociology.

Finally, we get to Miller’s own proposals. In part, these are for selective credit controls — direct limits on the volume of specific kinds of lending are likely to be more effective at reining in inflationary pressures, with less collateral damage. Yes, these kinds of direct controls pick winners and losers — no more than conventional policy does, just more visibly. As Miller notes, credit controls imposed for macroeconomic stabilization wouldn’t be qualitatively different from the various regulations on credit that are already imposed for other purposes — tho admittedly that argument probably went further in a time when private credit was tightly regulated than in the permanent financial Purge we live in today.

His other proposal is for comprehensive security reserve requirements — in effect generalizing the limits on bank lending to financial positions of all kinds. The logic of this idea is clear, but I’m not convinced — certainly I wouldn’t propose it today. I think when you have the kind of massive, complex financial system we have today, rules that have to be applied in detail, at the transaction level, are very hard to make effective. It’s better to focus regulation on the strategic high ground — but please don’t ask me where that is!

More fundamentally, I think the best route to limiting the power of finance is for the public sector itself to take over functions private finance currently provides, as with a public payments system, a public investment banks, etc. This also has the important advantage of supporting broader steps toward an economy built around human needs rather than private profit. And it’s the direction that, grudgingly but steadily, the response to various crises is already pushing us, with the Fed and other authorities reluctantly stepping in to perform various functions that the private financial system fails to. But this is a topic for another time.

Miller himself is rather tentative in his positive proposals. And he forthrightly admits that they are “like all credit control instruments, likely to be far more effective in controlling inflationary situations than in stimulating revival from a depressed condition.” This should be obvious — even Ronald Reagan knew you can’t push on a string. This basic asymmetry is one of the many everyday insights that was lost somewhere in the development of modern macro.

The conversation around monetary policy and macroeconomics is certainly broader and more realistic today than it was 15 or 20 years ago, when I started studying this stuff. And Jerome Powell — and even more the activists and advocates who’ve been shouting at him — deserves credit for the Fed;s tentative moves away from the reflexive fear of full employment that has governed monetary policy for so long. But when you take a longer look and compare today’s debates to earlier decades, it’s hard not to feel that we’re still living in the Dark Ages of macroeconomics

Alvin Hansen on Monetary Policy

The more you read in the history of macroeconomics and monetary theory, the more you find that current debates are reprises of arguments from 50, 100 or 200 years ago.

I’ve just been reading Perry Mehrling’s The Money Interest and the Public Interest, which is one of the two best books I know of on this subject. (The other is Arie Arnon’s Monetary Theory and Policy Since David Hume and Adam Smith.) About a third of the book is devoted to Alvin Hansen, and it inspired me to look up some of Hansen’s writings from the 1940s and 50s. I was especially struck by this 1955 article on monetary policy. It not only anticipates much of current discussions of monetary policy — quantitative easing, the maturity structure of public debt, the need for coordination between the fiscal and monetary policy, and more broadly, the limits of a single interest rate instrument as a tool of macroeconomic management — but mostly takes them for granted as starting points for its analysis. It’s hard not to feel that macro policy debates have regressed over the past 60 years.

The context of the argument is the Treasury-Federal Reserve Accord of 1951, following which the Fed was no longer committed to maintaining fixed rates on treasury bonds of various maturities. [1] The freeing of the Fed from the overriding responsibility of stabilizing the market for government debt, led to scholarly and political debates about the new role for monetary policy. In this article, Hansen is responding to several years of legislative debate on this question, most recently the 1954 Senate hearings which included testimony from the Treasury department, the Fed Board’s Open Market Committee, and the New York Fed.

Hansen begins by expressing relief that none of the testimony raised

the phony question whether or not the government securities market is “free.” A central bank cannot perform its functions without powerfully affecting the prices of government securities.

He then expresses what he sees as the consensus view that it is the quantity of credit that is the main object of monetary policy, as opposed to either the quantity of money (a non-issue) or the price of credit (a real but secondary issue), that is, the interest rate.

Perhaps we could all agree that (however important other issues may be) control of the credit base is the gist of monetary management. Wise management, as I see it, should ensure adequate liquidity in the usual case, and moderate monetary restraint (employed in conjunction with other more powerful measures) when needed to check inflation. No doubt others, who see no danger in rather violent fluctuations in interest rates (entailing also violent fluctuations in capital values), would put it differently. But at any rate there is agreement, I take it, that the central bank should create a generous dose of liquidity when resources are not fully employed. From this standpoint the volume of reserves is of primary importance.

Given that the interest rate is alsoan object of policy, the question becomes, which interest rate?

The question has to be raised: where should the central bank enter the market -short-term only, or all along the gamut of maturities?

I don’t believe this is a question that economists asked much in the decades before the Great Recession. In most macro models I’m familiar with, there is simply “the interest rate,” with the implicit assumption that the whole rate structure moves together so it doesn’t matter which specific rate the monetary authority targets. For Hansen, by contrast, the structure of interest rates — the term and “risk” premiums — is just as natural an object for policy as the overall level of rates. And since there is no assumption that the whole structure moves together, it makes a difference which particular rate(s) the central bank targets. What’s even more striking is that Hansen not only believes that it matters which rate the central bank targets, he is taking part in a conversation where this belief is shared on all sides.

Obviously it would make little difference what maturities were purchased or sold if any change in the volume of reserve money influenced merely the level of interest rates, leaving the internal structure of rates unaffected. … In the controversy here under discussion, the Board leans toward the view that … new impulses in the short market transmit themselves rapidly to the longer maturities. The New York Reserve Bank officials, on the contrary, lean toward the view that the lags are important. If there were no lags whatever, it would make no difference what maturities were dealt in. But of course the Board does not hold that there are no lags.

Not even the most conservative pole of the 1950s debate goes as far as today’s New Keynesian orthodoxy that monetary policy can be safely reduced to the setting of a single overnight interest rate.

The direct targeting of long rates is the essential innovation of so-called quantitative easing. [2] But to Hansen, the idea that interest rate policy should directly target long as well as short rates was obvious. More than that: As Hansen points out, the same point was made by Keynes 20 years earlier.

If the central bank limits itself to the short market, and if the lags are serious, the mere creation of large reserves may not lower the long-term rate. Keynes had this in mind when he wrote: “Perhaps a complex offer by the central bank to buy and sell at stated prices gilt-edged bonds of all maturities, in place of the single bank rate for short-term bills, is the most important practical improvement that can be made in the technique of monetary management. . . . The monetary authority often tends in practice to concentrate upon short-term debts and to leave the price of long-term debts to be influenced by belated and imperfect re- actions from the price of short-term debts.” ‘ Keynes, it should be added, wanted the central bank to deal not only in debts of all maturities, but also “to deal in debts of varying degrees of risk,” i.e., high grade private securities and perhaps state and local issues.

That’s a quote from The General Theory, with Hansen’s gloss.

Fast-forward to 2014. Today we find Benjamin Friedman — one of the smartest and most interesting orthodox economists on these issues — arguing that the one great change in central bank practices in the wake of the Great Recession is intervention in a range of securities beyond the shortest-term government debt. As far as I can tell, he has no idea that this “profound” innovation in the practice of monetary policy was already proposed by Keynes in 1936. But then, as Friedman rightly notes, “Macroeconomics is a field in which theory lags behind experience and practice, not the other way around.”

Even more interesting, the importance of the rate structure as a tool of macroeconomic policy was recognized not only by the Federal Reserve, but by the Treasury in its management of debt issues. Hansen continues:

Monetary policy can operate on two planes: (1) controlling the credit base – the volume of reserve balances- and (2) changing the interest rate structure. The Federal Reserve has now backed away from the second. The Treasury emphasized in these hearings that this is its special bailiwick. It supports, so it asserts, the System’s lead, by issuing short- terms or long-terms, as the case may be, according to whether the Federal Reserve is trying to expand or contract credit … it appears that we now have (whether by accident or design) a division of monetary management between the two agencies- a sort of informal cartel arrangement. The Federal Reserve limits itself to control of the volume of credit by operating exclusively in the short end of the market. The Treasury shifts from short-term to long-term issues when monetary restraint is called for, and back to short-term issues when expansion is desired.

This is amazing. It’s not that Keynesians like Hansen propose that Treasury should issue longer or shorter debt based on macroeconomic conditions. Rather, it is taken for granted that it does choose maturities this way. And this is the conservative side in the debate, opposed to the side that says the central bank should manage the term structure directly.

Many Slackwire readers will have recently encountered the idea that the maturities of new debt should be evaluated as a kind of monetary policy. It’s on offer as the latest evidence for the genius of Larry Summers. Proposing that Treasury should issue short or long term debt based on goals for the overall term structure of interest rates, and not just on minimizing federal borrowing costs, is the main point of Summers’ new Brookings paper, which has attracted its fair share of attention in the business press. No reader of that paper would guess that its big new idea was a commonplace of policy debates in the 1950s. [3]

Hansen goes on to raise some highly prescient concerns about the exaggerated claims being made for narrow monetary policy.

The Reserve authorities are far too eager to claim undue credit for the stability of prices which we have enjoyed since 1951. The position taken by the Board is not without danger, since Congress might well draw the conclusion that if monetary policy is indeed as powerful as indicated, nonmonetary measures [i.e. fiscal policy and price controls] are either unnecessary or may be drawn upon lightly.

This is indeed the conclusion that was drawn, more comprehensively than Hansen feared. The idea that setting an overnight interest rate is always sufficient to hold demand at the desired level has conquered the economics profession “as completely as the Holy Inquisition conquered Spain,” to coin a phrase. If you talk to a smart young macroeconomist today, you’ll find that the terms “aggregate demand was too low” and “the central bank set the interest rate too high” are used interchangeably. And if you ask, which interest rate?, they react the way a physicist might if you asked, the mass of which electron?

Faced with the argument that the inflation of the late 1940s, and price stability of the early 1950s, was due to bad and good interest rate policy respectively, Hansen offers an alternative view:

I am especially unhappy about the impli- cation that the price stability which we have enjoyed since February-March 1951 (and which everyone is justifiably happy about) could quite easily have been purchased for the entire postwar period (1945 to the present) had we only adopted the famous accord earlier … The postwar cut in individual taxes and the removal of price, wage, and other controls in 1946 … did away once and for all with any really effective restraint on consumers. Under these circumstances the prevention of price inflation … [meant] restraint on investment. … Is it really credible that a drastic curtailment of investment would have been tolerated any more than the continuation of wartime taxation and controls? … In the final analysis, of course, the then prevailing excess of demand was confronted with a limited supply of productive resources.

Inflation always comes down to this mismatch between “demand,” i.e. desired expenditure, and productive capacity.

Now we might say in response to such mismatches: Well, attempts to purchase more than we can produce will encourage increased capacity, and inflation is just a temporary transitional cost. Alternatively, we might seek to limit spending in various ways. In this second case, there is no difference of principle between an engineered rise in the interest rate, and direct controls on prices or spending. It is just a question of which particular categories of spending you want to hold down.

The point: Eighty years ago, Keynes suggested that what today is called quantitative easing should be a routine tool of monetary policy. Sixty years ago, Alvin Hansen believed that this insight had been accepted by all sides in macroeconomic debates, and that the importance of the term structure for macroeconomic activity guided the debt-issuance policies of Treasury as well as the market interventions of the Federal Reserve. Today, these seem like new discoveries. As the man says, the history of macroeconomics is mostly a great forgetting.

[1] I was surprised by how minimal the Wikipedia entry is. One of these days, I am going to start having students improve economics Wikipedia pages as a class assignment.

[2] What is “quantitative about this policy is that the Fed buys a a quantity of bonds, evidently in the hopes of forcing their price up, but does not announce an explicit target for the price. On the face of it, this is a strangely inefficient way to go about things. If the Fed announced a target for, say, 10-year Treasury bonds, it would have to buy far fewer of them — maybe none — since market expectations would do more of the work of moving the price. Why the Fed has hobbled itself in this way is a topic for another post.

[3] I am not the world’s biggest Larry Summers fan, to say the least. But I worry I’m giving him too hard a time in this case. Even if the argument of the paper is less original than its made out to be, it’s still correct, it’s still important, and it’s still missing from today’s policy debates. He and his coauthors have made a real contribution here. I also appreciate the Hansenian spirit in which Summers derides his opponents as “central bank independence freaks.”

Boulding on Interest

Kenneth Boulding, reviewing Maurice Allais’s Économie et intérêt in 1951:

Much work on the theory of interest is hampered at the start by its unquestioned assumption that “the” rate of interest, or even some complex of rates, is a suitable parameter for use in the construction of systems of economic relationships, whether static or dynamic. This is an assumption which is almost universally accepted and yet which seems to me to be very much open to question. My reason for questioning it is that the rate of interest is not an objective magnitude… The rate of interest is not a “price”; its dimensions are those of a rate of growth, not of a ratio of exchange, even though it is sometimes carelessly spoken of as a “price of loanable funds.” What is determined in the market is not strictly the rate of interest but the price of certain “property rights.” These may be securities, either stocks or bonds, or they may be items or collections of physical property. Each of these property rights represents to an individual an expected series of future values, which may be both positive and negative. If this expected series of values can be given some “certainty equivalent” … then the market price of the property determines a rate of interest on the investment. This rate of interest, however, is essentially subjective and depends on the expectations of the individual; the objective phenomenon is the present market price…

It is only the fact that the fulfilment of some expectations seems practically certain that gives us the illusion that there is an objective rate of interest determined in the market. But in strict theory there is no such certainty, even for gilt-edged bonds; and when the uncertainties of life, inflation, and government are taken into consideration, it is evident that this theoretical uncertainty is also a matter of practice. What is more, we cannot assume either that there are any “certain equivalents” of uncertain series for it is the very uncertainty of the future which constitutes its special quality. What this means is that it is quite illegitimate even to begin an interest theory by abstracting from uncertainty or by assuming that this can be taken care of by some “risk premium”; still less is it legitimate to construct a whole theory on these assumptions … without any discussion of the problems which uncertainty creates. What principally governs the desired structure of assets on the part of the individual is the perpetual necessity to hedge — against inflation, against deflation, against the uncertainty in the future of all assets, money included. It is these uncertainties, therefore, which are the principal governors of the demand and supply of all assets without exception, and no theory which abstracts from these uncertainties can claim much significance for economics. Hence, Allais is attempting to do something which simply cannot be done, because it is meaningless to construct a theory of “pure” interest devoid of premiums for risk, liquidity, convenience, amortization, prestige, etc. There is simply no such animal.

In other words: There are contexts when it is reasonable to abstract from uncertainty, and proceed on the basis that people know what will happen in the future, or at least its probability distribution. But interest rates are not such a context, you can’t abstract away from uncertainty there. Because compensation for uncertainty is precisely why interest is paid.

The point that what is set in the market, and what we observe, is never an interest rate as such, but the price of some asset today in terms of money today, is also important.

Boulding continues:

The observed facts are the prices of assets of all kinds. From these prices we may deduce the existence of purely private rates of return. The concept of a historical “yield” also has some validity. But none of these things is a “rate of interest” in the sense of something determined in a market mechanism.

This search for a black cat that isn’t there leads Allais into several extended discussions of almost meaningless and self-constructed questions… Thus he is much worried about the “fact” that a zero rate of interest means an infinite value for land, land representing a perpetual income, which capitalized at a zero rate of interest yields an infinite value… This is a delightful example of the way in which mathematics can lead to an almost total blindness to economic reality. In fact, the income from land is no more perpetual than that from anything else and no more certain. … We might draw a conclusion from this that a really effective zero rate of interest in a world of perfect foresight would lead to an infinite inflation; but, then, perfect foresight would reduce the period of money turnover to zero anyway and would give us an infinite price level willy-nilly! This conclusion is interesting for the light it throws on the complete uselessness of the “perfect foresight” model but for little else. In fact, of course, the element which prevents both prices from rising to infinity and (private) money rates of interest from falling to zero is uncertainty – precisely the factor which Allais has abstracted from. Another of these quite unreal problems which worries him a great deal is why there is always a positive real rate of interest, the answer being of course that there isn’t! …

Allais reflects also another weakness of “pure”interest theory, which is a failure to appreciate the true significance and function of financial institutions and of “interest” as opposed to “profit” – interest in this sense being the rate of growth of value in “securities,” especially bonds, and “profit” being the rate of growth of value of items or combinations of real capital. Even if there were no financial institutions or financial instruments … there would be subjective expected rates of profit and historical yields on past, completed investments. In such a society, however, given the institution of private property, everyone would have to administer his own property. The main purpose of the financial system is to separate “ownership” (i.e., equity) from “control,” or administration, that is, to enable some people to own assets which they do not control, and others to control assets which they do not own. This arrangement is necessitated because there is very little, in the processes by which ownership was historically determined through inheritance and saving, to insure that those who own the resources of society are … capable of administering them. Interest, in the sense of an income received by the owners of securities, is the price which society pays for correcting a defect in the otherwise fruitful institution of private property. It is, of course, desirable that the price should be as small as possible – that is, that there should be as little economic surplus as possible paid to nonadministering owners. It is quite possible, however, that this “service” has a positive supply price in the long run, and thus that, even in the stationary state, interest, as distinct from profit, is necessary to persuade the nonadministering owners to yield up the administration of their capital.

This last point is important, too. Property, we must always remember, is not a relationship between people and things. it is a relationship between people and people. Ownership of an asset means the authority to forbid other people from engaging in a certain set of productive activities. The “product” of the asset is how much other people will pay you not to exercise that right. Historically, of course, the sets of activities associated with a given asset have often been defined in relation to some particular means of production. But this need not be the case. In a sense, the patent or copyright isn’t an extension of the idea of property, but property in its pure form. And even where the rights of an asset owner are defined as those connected with some tangible object, the nature of the connection still has to be specified by convention and law.

According to Wikipedia, Économie et intérêt, published in 1947, introduced a number of major ideas in macroeconomics a decade or more before the American economists they’re usually associated with, including the overlapping generations model and the golden rule for growth. Boulding apparently did not find these contributions worth mentioning. He does, though, have something to say about Allais’s “economic philosophy” which “is a curious combination of Geseel, Henry George and Hayek,” involving “free markets, with plenty of trust- and union-busting, depreciating currency, and 100 per cent reserves in the banking system, plus the appropriation of all scarcity rents and the nationalization of land.” Boulding describes this as “weird enough to hit the jackpot.” It doesn’t seem that weird to me. It sounds like a typical example of a political vision you can trace back to Proudhon and forward through the “Chicago plan” of the 1930s and its contemporary admirers to the various market socialisms and more or less crankish monetary reform plans. (Even Hyman Minsky was drawn to this strain of politics, according to Perry Mehrling’s superb biographical essay.)What all these have in common is that they see the obvious inconsistency between capitalism as we observe it around us and the fairy tales of ideal market exchange, but they don’t reject the ideal. Instead, they propose a program of intrusive regulations to compel people to behave as they are supposed to in an unregulated market. They want to make the fairy tales true by legislation. Allais’ proposal for currency depreciation is not normally part of this package; it’s presumably a response to late-1940s conditions in France. But other than that these market utopias are fairly consistent. In particular, it’s always essential to reestablish the objectivity of money.

Finally, in a review full of good lines, I particularly like this one:

Allais’s work is another demonstration that mathematics and economics, though good complements, are very imperfect substitutes. Mathematics can manipulate parameters once formulated and draw conclusions out which were already implicit in the assumptions. But skills of the mathematician are no substitute for the proper skill of the economist, which is that of selecting the most significant parameters to go into the system.