Saturday, October 26, 2013

Desperately seeking the natural rate of interest

The Economist Free Exchange (FE) blog gets into the debate of where is the elusive natural rate of interest. I've already discussed Krugman's views (see here and here) that the natural rate of interest is negative, and that's why we need fiscal policy, something that he refers to as the Liquidity Trap. FE suggests that William White, formerly from the Bank of International Settlements (BIS) and now from the Organization for Economic Cooperation and Development (OECD), believes that the natural rate is higher than the monetary rate.

According to FE White believes that: "the Wicksellian natural rate must be high and monetary policy too loose because low rates have encouraged all sorts of yield-chasing behavior." If one reads White's paper, we find that he says more precisely the following:
"Moreover, given this particular way of thinking and noting that the financial rate is now constrained by the ZLB [zero lower bound interest rate], this gap can only be redressed by raising the natural rate to encourage investment."
In other words, he believes that central banks, like the Fed, can move the natural rate, by affecting savings behavior presumably associated with inflationary expectations. This would lead to a monetary rate that is lower than the natural rate and increased investment. This is actually the same story that Krugman has favored, which I suggested is an inflationary expectations confidence fairy.

Interestingly enough, still according to FE, DeLong, who seems to be on the same page with Krugman, has responded to White, if FE's description is correct, suggesting that there is little that the Fed can do about the natural rate, and is stuck with a very low monetary rate for a while.

Mind you, the search for the holy grail of the natural rate is futile anyway (yep capital debates; it's been a while). And no act of the Fed will lead to more inflationary expectations and higher spending. And because of the Tea Party, and also fiscal hawks in the Democratic Party, there is no hope for fiscal stimulus. This FE post shows the incredible confusion of the mainstream.

PS: In this post FE also tells us that the natural rate of unemployment is 5.5%. Oh well.


  1. Matias, can you clarify your argument here? Are you saying that there is no reason to think that a lower real interest rate (however achieved) would raise demand? Or are you just saying that it is unhelpful to describe the interest rate we would like as "natural"?

  2. The link to the Free Exchange blog doesn't work


Raúl Prebisch: Peripheral Development

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