How are interest rates determined? Böhm-Bawerk vs. the Neoclassical School

Jesús Huerta de Soto discusses the differences in two schools:

Neoclassical economists believe that capital supply and demand jointly determine the interest rate in equilibrium, that subjective considerations of time preference determine supply, but that entrepreneurs determine demand based on the marginal productivity of capital (that is, based on predominantly objective considerations). This approach parallels the one that Marshall developed to explain price determination in the market, and that Böhm-Bawerk and the Austrian school reject and emphasize that when entrepreneurs demand funds, they act as mere intermediaries for workers and owners of factors of production, who are the final demanders of present goods in the form of wages and rents, and in exchange they transfer to entrepreneurs the ownership of future goods of greater value (which will only become available when the process of production concludes).

Consequently, from the perspective of Austrian economists, both sides – the supply of capital goods and the demand for them – depend on subjective considerations of time preference. This line of argument, in the area of interest rate determination, echoes the one that Böhm-Bawerk employed with Marshall when he criticized Marshall for his desire to preserve, at least on one side of the process of price determination, the old objectivist, Ricardian conception characteristic of the classical school of economics.

There is lots more in the piece….


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