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(...) Sraffa, it turned out, was one of the few English-speaking economists equiped to mediate between the two theoris, being intimately familiar with the work of Keynes (...) as well as "being familiar with both Vilfredo Pareto's theory of general equilibrium and the Austrian theory of capital and interest of Boehm-Bawerk and Wicksell"(Kurz, 2000: 283). What resulted was a trenchant critique of Hayek's book ^Prices and Production^, one still considered to be one of the most formidable critiques of the Austrian school, and it remains unrefuted.
- A difficult to interpret and ambiguous way-station between Sraffa's early work on the distributional aspects of monetary policy, and his later full-blown critique of orthodox economic theory (Panico, 1988)
- The analytical basis of Keynes's most elaborate ^General Theory^ analysis of the 'essential properties of interest and money' (Deleplace, 1986; Majewski, 1988; Kregel, 1982; Mongiovi, 1990; Potestio, 1986; Rymes, 1978).
- The opening shots by Sraffa of a planned counter-revolution against subjectivism which culminated 30 years later with the ^Production of Commodities by Means o Commodities^ (Lachmann, 1986; Caldwell, 1986).
- An early discussion of the true problems associated with the attempt to integrate money into a Walrasian general equilibrium model, and the forerunner of the modern mathematical treatment of the issue (Desai, 1982; McCloughry, 1982)
Hayek's argument centers on the relation between interest rates and the amount of capital used by firms. Following the work of Wicksel, Hayek adopts the notion of the 'natural rate of interest'ㅡan equilibrium rate which will equalize the supply of capital with the demand for the products it creates.
- If the rate of interest set by the bank is lower than the natural rate, Hayek proposes, producers will have an incentive to borrow money from the banks to invest into capital, since they will pay less on interest than they would normally.
- This increase in capital allows the firm to improve its production capacity, but since demand has not significantly changed, an extra goods that it produces will not be purchased unless it lowers the price, which would reduce the firm's profit. Therefore, the firm instead uses its extra capital to produce higher-quality goods which require more capital for their production, and which the firm will correspondingly be able to sell for a higher price.
- This also, Hayek (following Boehm-Bawerk) points out, requires a "lengthening of the period of production," and in the interim where no goods are being sold, consumers have no choice but to save their money. Hayek refers to this as "forced saving," and denounces it for interfering with individual freedom. There are other, more insidious results of 'forced saving', however:
Eventually incomes will rise; and since preferences of agents have not changed, consumption demand will go up. Prices of consumer goods will rise, indicating to producers that it is profitable to adopt less ‘roundabout [i.e., time- and capital-intensive]’ processes of production. As a consequence, capital has to be reduced againㅡa process that "necessarily takes the form of an economic crisis" (Hayek, ^Prices and Production^, p. 53). After a costly roundtrip, and on the assumption that the banking system will eventually correct its error, the system is bound to return its original equilibrium. [Kurz (1999)]
Kurz, H. (1999). “Sraffa’s Reception of the German Economics Literature: A Few Examples.” Storia del Pensiero Economico, (37).
Kurz, H. “The Hayek–Keynes–Sraffa Controversy Reconsidered,” in Kurz, H. (Ed.). (2000). Critical Essays on Piero Sraffa’s Legacy in Economics. Cambridge, UK: Cambridge University Press.
As a result, Hayek advocate a policy where banks keep the interest rates equal to the 'natural rate', both in order to preserve individual freedom (i.e., 'voluntary saving') and to prevent economic crisis.
- One such element is “the alleged permanence of the capital accumulated in the voluntary [saving] case as opposed to the ‘inevitable’ destruction of that accumulated in the forced saving case” (Lawler & Horn, 326). Hayek thus assumes a mechanism that will re-establish the proportion of money income saved and consumed after the expansion to the level they were before the expansion.
- Sraffa, for the sake of critique, supposes that such a mechanism did exist. He then finds a problem in distinguishing the results of forced saving from those of voluntary saving: “[f]or Sraffa, one income has been redistributed by...inflation and saved in the form of capital assets, [and] there is nothing to distinguish those assets from 'voluntarily' accumulated assets” (Ibid, 327).
- This, as Hayek himself admits, is the central point of his theory: if the capital accumulated by the firm does not dissipate due to an 'inevitable' economic crisis, then 'forced saving' will bring about just about the exact same results as will voluntary saving. Such dissipation would need to happen as a result of redirection of income from producers to consumers through an increase of spending on the consumer's part, and a decrease in the producer's part, the quantity of money being held constant.
- Sraffa then notes that "[i]f the essential element of the story is the change in proportions of the spending stream, it cannot be monetary expansions themselves that account for the crisis," showing that "something other than monetary effects are in fact responsible for Hayek's conclusions" (ibid, 328). Sraffa concludes that the mechanism directing the proportionate spending of consumers and producers is "the supposed power of the banks to settle the way in which money is spent ... As Voltaire says, you can kill a flock of sheep by incantations, plus a little poison" (Sraffa, 49).
Lastly, Sraffa goes on to show the problem inherent in the concept of a 'natural rate' of interest. Recalling that Hayek's model is formally identical with a non-monetary barter economy, it follows that any commodity could conceivably be used as the 'standard' by which everything else is valued. What this means in practice, however, is that as many different rates of interest could obtain in that economy as there are commoditiesㅡand these would all by definition be 'natural rates', though they would not be equilibrium rates. Consequently, Hayek is incorrect in automatically identifying the 'natural rate' with the equilibrium rate. In fact, in an expanding economy there will be no one equilibrium rate, since 'natural rates' of interest will be different for different commodities. Accordingly, the idea that 'forced saving' is caused by an interest rate (set by the banks) below the natural rate makes no sense, since there is no single natural rates with which the bank rate should (optimally) be equal.
This leads to the death blow for Hayek's theory:
In his reply Hayek admitted that "there would be ^no single rate^ which, applied to all commodities, would satisfy the conditions of equilibrium rates, but there might, at any moment, be as many "natural" rates of interest as there are commodities, ^all^ of which would be ^equilibrium rates^" (1932, p. 245). In his rejoinder, Sraffa noticed Hayek's admission with satisfaction, but he asked him to draw the consequences for his ideal maxim for monetary policyㅡthe proposition that they "all [...] would be equilibrium rates". Sraffa commented: "The only meaning (if it be a meaning) I can attach to this is that his maxim of policy now requires that the money rate should be equal to all the divergent natural rates" (1932, p. 251). [Kurz (1999)]