Value & Capital, CHAPTER XVII, Section 7

In this section, the author reviews what he has written in this chapter by noting that, "I may have laid myself open to the charge of having done nothing but state simple things in a complicated way." He justifies this, however, by the need of explaining where Böhm-Bawerk went wrong in developing the "Austrian theory."

He also restates the general conclusion of this chapter, namely "that changes in the rate of interest affect the 'tilt' or crescendo of the production plan."

He then turns to explaining a further point, which he says is "of much greater practical importance than those with which we have been labouring." This point has to do with the conditions under which the interest rate has a significant influence.

For near-term planning, he asserts that changes in interest rates within the normal range (such as between 2 and 7 percent) probably do not have much of an effect on business decisions. If entrepreneurs are "living from hand to mouth," interest rate effects will not be significant.

Conversely, for longer-term decisions, interest rate changes do have a signficant effect; but, as the text explains, considerations of risk will have an even greater effect.

As we have often seen, the effective 'expected price' of a future output ... is not the most probable price, but the most probable price minus an allowance for risk. Now the farther ahead the future output is, the larger this risk-allowance is likely to become, just because the uncertainty of the future price increases; after a certain point, therefore, the risk-allowance will become so large as to wipe out any possible gains, and the effective 'expected price' will become nil.

Thus, the author concludes that in near-term planning, interest will not have a significant influence, and "risk is too strong to enable interest to have much influence on the far future." He suggests that between these two extreme cases, there is likely a range of intermediate cases in which interest can have a significant influence. The extent of this range depends on the prevailing attitude toward risk.

Value & Capital, CHAPTER XVII, Section 6

In this section the author, Sir John Hicks, explains what was mistaken in Böhm-Bawerk’s concept of the ‘average period of production’ (which Hicks also refers to as ‘the Austrian theory’).  Böhm-Bawerk had reasonably focused on a simple case of production:  namely, “the case where all the input is utilized at one given date, and all the output comes to fruition at another given date.”  The analysis is correct in this case, but, as Hicks notes, the result “does not generalize in the sort of way in which it might have been expected to generalize.”

Instead, in the general case,

The absolute length of the true average period has no significance whatsoever; it depends only in part upon the character of the production plan; it will be lengthened and shortened in an entirely arbitrary manner according as we calculate the average period of the same plan at different rates of interest. Change in the average period is important, but not the length of the period itself. The average period measures nothing else but the crescendo of the plan; and that has nothing to do with the technical methods of production employed.

To clarify the point further, Hicks gives a simple example to illustrate the properties involved.  His example considers a particular firm whose production consists of a number of separate processes, each of which takes n weeks to complete. In any given week, some of the previously started processes are completed, and new ones are started to take their place.  He assumes that the firm is initially in a stationary equilibrium state, with m processes finishing each week, and m new ones begun to replace them.  Thus mn of these processes are being conducted each week, and “the streams of total inputs and total output are both constant over time.”  The firm is assumed to have chosen the number mn "for reasons of risk;  risk-coefficients increase as the scale of output expands; the entrepreneur declines to undertake extra processes, because their capitalized value (allowance being made for risk) would be negative."

If there is a fall in the interest rate, it may be profitable to start some new processes that were not profitable before.  The author states that the inception of these new processes, undertaken only because of the fall in the interest rate, "must raise the average period of the plan."  To explain this, note that these less profitable processes may have, in a sense, a longer payback period.  Even if they do not (that is to say, even if they have the same properties as the other processes), the increased investment in them (in exchange for later profits) will have the effect of diminishing the current surplus and increasing some later surpluses.  In other words, as the author concludes, "the stream is given a crescendo."

Personal note:  Just over 24 hours ago, I was vaccinated against COVID-19, so my hope is that in two weeks or so, I will have escaped the recent global pandemic.