Now you can see why this concept of a ‘natural rate’ might be important. Maybe current market rates are too high compared to the natural rate so that we have a glut of saving (hoarding of money) and not enough investment – stagnation. But maybe market rates are too low, below the natural rate, so that we have inflation being expressed in a bubble in property and financial assets. This is the nature of the argument between the conservative neo-classical (Austrians) and the Keynesians.
As leading Keynesian Brad Delong put it: “Bill White, formerly of the Bank for International Settlements, has argued the Wicksellian natural rate must be high and monetary policy too loose because low rates have encouraged all sorts of yield-chasing behavior. But [W]e don’t see businesses dipping into their cash reserves to fund investment; a monetary hot potato; unexpected and rising inflation; and full or over-full employment. Instead, we see elevated unemployment and firms and households adding to their cash reserves. This is what Wicksell expected to see when the natural rate of interest was below the market rate: planned investment would then be lower than desired savings, households and businesses seeking to save would then transfer some of their cash out of transactions balances and treat them as unspendable savings (the « precautionary » or « speculative » demand for money), we would see too little money to buy all the goods and services that would be put on sale at full employment, and we would see no signs of inflation but a depressed economy. That is the root of our problem: the natural nominal rate of interest … today is less than zero, and so the Federal Reserve cannot push the market nominal rate of interest down low enough. »
But is there a natural rate of interest? Does this concept help us understand what is happening in an economy, especially in the major capitalist economies right now? Well, Keynes dismissed the idea arguing that there was not one static natural rate but a series of rates depending on the level of investment, consumption and saving in an economy and the desire to hoard money (liquidity preference). And there was no reason to assume that the capitalist economy would ‘correct’ any mismatch between investment and savings, particularly in a depression, by market interest rates adjusting back to the ‘natural rate’ in some automatic market process. That’s because in a depression where investment returns are too low compared to the money rate of interest, capitalists will hoard their money rather than invest in a ‘liquidity trap’.
Marx too denied the concept of a natural rate of interest. For him, the return on capital, whether exhibited in the interest earned on lending money, or dividends from holding shares, or rents from owning property, came from the surplus-value appropriated from the labour of the working class and appropriated by the productive sectors of capital. Interest was a part of that surplus value. The rate of interest would thus fluctuate between zero and the average rate of profit from capitalist production in an economy. In boom times, it would move towards the average rate of profit and in slumps it would fall towards zero. But the decisive driver of investment would be profitability, not the interest rate. If profitability was low, then holders of money would increasingly hoard money or speculate in financial assets rather than invest in productive ones. What matters is not whether the market rate of interest is above or below some ‘natural’ rate but whether it is so high that it is squeezing any profit for investment in productive assets.
Both Keynes and Marx looked not to a concept of a natural rate of interest’ but to the relation of interest rate for holding money to the profitability (or return) on productive capital. Actually, so did Wicksell. According to Wicksell, the natural rate is “never high or low in itself, but only in relation to the profit which people can make with the money in their hands, and this, of course, varies. In good times, when trade is brisk, the rate of profit is high, and, what is of great consequence, is generally expected to remain high; in periods of depression it is low, and expected to remain low.”
More recently, the architect of modern ‘unconventional monetary policy as the solution to the ills of modern capitalism, Ben Bernanke, former chief of the US Fed, agreed. Bernanke tells us that low interest rates are here to stay, but not because of lax monetary policy, but because the real rate of return on assets (both tangible and financial) are staying low. They are low not because the Fed and other central banks have pumped too much money into the economy – although that used to be what Ben said he wanted to do. No, the reason for low interest rates is the low rate of return on capital investment. “The real interest rate is most relevant for capital investment decisions, for example. The Fed’s ability to affect real rates of return, especially longer-term real rates, is transitory and limited. Except in the short run, real interest rates are determined by a wide range of economic factors, including prospects for economic growth—not by the Fed.”
There has been an eruption of an old debate among mainstream economics bloggers. The debate is about, first, whether there is a ‘natural rate of interest’ that provides equality between investment and savings in an economy at full employment; and second, whether current interest rates in the major economies are above or below that ‘natural’ rate.
The concept of a ‘natural’ rate where desired investment in new structures, equipment and technology matches desired saving by households and firms in a ‘general equilibrium’ comes from the neoclassical economist of the late 19th century Knut Wicksell. He argued that if investment exceeded savings in an economy, the natural rate would rise so that savings would then increase to match investment and vice versa. If for some reason, the natural rate did not rise, then there would ‘overheating’ in the economy, in the form of inflation. In the recession example…
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