A Circular Argument

["John Tyler" <j_tyler@xxxxxxxxxxx>]

                          A Circular Argument

    In chapter 16 of Keynes' General Theory, he makes it quite clear that
interest is due to the fact that capital is scarce, not that it is
productive.  This is obviously part of Keynes' thought that did not make it
into the neoclassical synthesis.  However, it can be brought to the
forefront with a very simple argument.
    The standard argument for interest, based on the marginal productivity
of capital, is circular.  This observation is more important than the
existence of reswitching, since it calls into question the very existence of
interest.
    It is commonly said in the profession that interest is equal toi the
marginal product of capital.  However, in the real world, capital
depreciates, and this depreciation must be recognized.  Equating interest to
the marginal product of capital is not just a bit of Friedmanesque
unrealism.  The assumption that capital does not depreciate is not robust;
there are important consequences from relaxing that assumption.  The best
theorists, like Milton Friedman and Paul Samuelson, have recognized that
interest must be equal to the marginal net product of capital, marginal
product minus depreciation, but they seem not to have realized all the
consequences of recognizing depreciation.
    Once we recognize depreciation, the standard marginal rpoductivity
argument for interest becomes obviously circular.  The rate of interest
depends on the charge for depreciation, which depends in part on the present
value of capital goods.  However, the present value of capital goods depends
on the rate of interest, and thus the argument is circular.
    The argument given here can give the neoclassicals more fits than
reswitching because it is more fundamental.

John Tyler


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