When long-term Treasury yields rise, one explanation is often given: investors expect more inflation, so lenders demand a higher nominal rate to offset the future loss of purchasing power. Expected inflation is treated as an addition to an otherwise “real” rate. Murray Rothbard argued that this begins in the wrong place.
Rothbard’s Argument
In Man, Economy, and State, Rothbard says economists following Irving Fisher “erred by concentrating on the loan rate rather than on the natural rate.” The natural rate is the return earned across production when present factors are exchanged for future products. The loan rate reflects that broader market because investors compare loans with businesses, stocks, capital goods, and every other use of present money.
Rothbard illustrates the error with an expected 50 percent fall in prices. Fisher’s reasoning could imply lending 100 gold ounces today for only 53 next year since those ounces would buy more. Yet the lender could simply hold the 100 ounces. Rothbard then turns to production. If entrepreneurs normally pay 100 ounces for factors and sell the product for 105, an expected halving of the future selling price will make them cut their present bids for factors toward 50. The underlying return remains about 5 percent.
The same logic applies to expected inflation. If future selling prices are expected to double, entrepreneurs bid up labor, land, materials, and intermediate goods now. Anticipation changes present prices rather than mechanically adding a premium to interest. Rothbard states the point directly:
The purchasing-power component, then, is not the reflection, as has been thought, of expectations of changes in purchasing power. It is the reflection of the change itself; indeed, if the change were completely anticipated, the purchasing power would change immediately, and there would be no room for a purchasing-power component in the rate of interest. As it is, partial anticipations speed up the adjustment of the PPM to the changed conditions.
The purchasing-power component disappears to the degree the monetary change is anticipated. If an anticipated depreciation initially makes a nominal bond unusually cheap and its yield unusually high relative to other investments, capital moves into the bond, bidding its price up until returns are again aligned.
What Can Still Move Interest Rates?
Rothbard does not claim that monetary disturbances leave observed rates unchanged. He distinguishes the pure rate determined by time preference, specific entrepreneurial components, the ephemeral purchasing-power component, and a terms-of-trade component.
The terms-of-trade component arises because product prices and factor prices do not move together. If the prices businesses receive rise faster than wages, rents, and materials, prospective returns widen and entrepreneurs compete more aggressively for credit. If factor costs move first, returns narrow. The relevant question is not merely how much “the price level” is expected to rise, but which prices change relative to which others.
The entrepreneurial component reflects uncertainty about the amount, timing, path, and reversal of monetary intervention. Kristoffer Mousten Hansen develops this part of Rothbard’s analysis by treating monetary effects on interest as Cantillon effects: their direction depends on where new money enters and how it changes particular product, factor, and financial-market prices.
The Bond-Market Implication
Robert Murphy makes the useful equilibrium point in episode 493 of the Bob Murphy Show at 53:56. After a doubling of the money stock has been fully incorporated into prices, nominal rates on dollar-denominated debts do not also double:
If originally interest rates were 5 percent, and then the quantity of money doubles, once everything settles down. . .it’s not that the 5 percent interest rates are now permanently 10 percent. No, they’re still 5 percent.
Murphy also discusses a temporary bond-yield spike during the adjustment. Rothbard’s formulation supplies the essential discipline: to the extent the monetary depreciation is anticipated, that portion is incorporated into present prices and competed away. Any remaining yield movement must therefore be traced to time preference, terms-of-trade effects, entrepreneurial judgments, nonneutral money flows, or characteristics of the security itself.
This changes how Rothbardians should describe modern bond markets. We should not say that long-term rates rose because quantitative easing—or Federal Reserve purchases concentrated at the short end—raised inflation expectations. That simply imports the Fisherian premium Rothbard rejected. We should identify the intervening mechanism: Did money enter or leave a credit market? Did expected product prices outrun factor costs? Did private credit demand change? Did anticipated policy reversal, Treasury issuance, liquidity, or uncertainty alter relative returns?
Higher CPI expectations may accompany those developments, but they do not explain them by themselves. The same caution applies to TIPS breakevens. The spread between a nominal Treasury and a CPI-linked security can reflect terms-of-trade, entrepreneurial, liquidity, tax, indexation, and official-purchase effects. Nor is the CPI a direct measure of a single “price level”; Rothbard regarded purchasing power as an array of individual exchange ratios, not one objectively measurable number.
Conclusion
Rothbard’s critique changes the burden of explanation of long-term interest rates. The anticipated portion of a purchasing-power change is capitalized into present prices and arbitraged away to the degree it is anticipated. A residual change in long-term yields must be explained by the other components Rothbard identified—not by assuming that an inflation forecast was added to the natural rate.
