(A year ago, I mentioned that Arjun Jayadev were writing a book about money. The project was then almost immediately derailed by covid, but we’ve recently picked it up again. I’ve decided to post some of what we’re writing here. Plucked from its context, it may be a bit unclear both where this piece is coming from and where it is going.)
The problem of interest rates is one of the key fissures between the vision of the economy in terms of the exchange of real stuff and and the reality of a web of money payments. Like a flat map laid over a globe, a rigid ideological vision can be made to lie reasonably smoothly over reality in some places only at the cost of ripping or crumpling elsewhere; the interest rate is one of the places that rips in the smooth fabric of economics most often occur. As such, it’s been a central problem since the emergence of economics as a distinct body of thought. How does the “real” rate determined by saving and investment demand get translated into the terms set for the exchange of IOUs between the bank and its customer?
One straightforward resolution to the problem is simply to deny that money plays a role in the determination of the interest rate. David Hume’s central argument in his essay “On Interest” (one of the first discussions within the genealogy of modern economics) was that changes in the supply of money do not affect the interest rate.1
High interest arises from three circumstances: A great demand for borrowing; little riches to supply that demand; and great profits arising from commerce: And these circumstances are a clear proof of the small advance of commerce and industry, not of the scarcity of gold and silver… Those who have asserted, that the plenty of money was the cause of low interest, seem to have taken a collateral effect for a cause…. though both these effects, plenty of money and low interest, naturally arise from commerce and industry, they are altogether independent of each other.
“Riches” here means real, material wealth, so this is an early statement of what we would today call the loanable-funds view of interest rates. Similar strong claims have been taken up by some of today’s more doctrinaire classical economists, in the form of what is known as neo-Fisherism. If the “real” rate, in the sense of the interest rate adjusted for inflation, is set by the fundamentals of preferences and technology, then central bank actions must change only the nominal rate. This implies that when the central bank raises the nominal interest rate, that must cause inflation to rise — not to fall, as almost everyone (including the central bankers!) believes. Or as Minneapolis Federal Reserve president Narayana Kocherlakota put it, if we believe that money is neutral, then “over the long run, a low fed funds rate must lead to … deflation.”2 This view is, not surprisingly, also popular among libertarians.
The idea that monetary influences on the interest rate are canceled out by changes in inflation had a superficial logic to it when those influences were imagined as a literal change in the quantity of money — of the relative “scarcity of gold and silver,” as Hume put it. If we imagine expansionary monetary policy as an increase in the fixed stock of money, then it might initially make money more available via loans, but over time as that money was spent, it would lead to a general rise in prices, leaving the real stock of money back where it started.
But in a world where the central bank, or the private banking system, is setting an interest rate rather than a stock of money, this mechanism no longer works. More money, plus higher prices, leaves the real stock of money unchanged. But low nominal rates, plus a higher rate of inflation, leaves the real interest rate even lower. In a world where there is a fixed, central bank-determined money stock, the inflation caused by over-loose policy will cancel out that policy. But when the central bank is setting an interest rate, the inflation caused by over-loose policy implies an even lower real rate, making the error even worse. For the real rate to be ultimately unaffected by monetary policy, low interest rates must somehow lead to lower inflation. But it’s never explained how this is supposed to come about.
Most modern economists are unwilling to outright deny that central banks or the financial system can affect the rate of interest.3 Among other things, the privileged role of the central bank as macroeconomic manager is a key prop of policy orthodoxy, essential to stave off the possibility of other more intrusive forms of intervention. Instead, the disjuncture between the monetary interest rate observable in credit markets and the intertemporal interest rate of theory is papered over by the notion of the “natural” interest rate.
This idea, first formulated around the turn of the 20th century by Swedish economist Knut Wicksell, is that while banks can set any interest rate they want, there is only one interest rate consistent with stable prices and, more broadly, appropriate use of society’s resources. It is this rate, and not necessarily the interest rate that obtains at any given moment, that is set by the nonmonetary fundamentals of the economy, and that corresponds to the intertemporal exchange rate of theory. In the classic formulation of Milton Friedman, the natural rate of interest, with its close cousin the natural rate of unemployment, correspond to the rates that would be “ground out by the Walrasian system of general equilibrium equations, provided there is imbedded in them the actual structural characteristics of the labor and commodity markets, including market imperfections, stochastic variability in demands and supplies, the cost of gathering information about job vacancies and labor availabilities, the costs of mobility, and so on.”
The natural rate of interest is exactly the rate that you would calculate from a model of a rational individual trading off present against future — provided that the model was actually a completely different one.
Despite its incoherence, Friedman’s concept of the natural rate has had a decisive influence on economic thinking about interest in the 50 years since. His 1968 Presidential Address to the American Economics Association introducing the concept (from which the quote above comes) has been called “very likely the most influential article ever published in an economics journal” (James Tobin); “the most influential article written in macroeconomics in the past two decades” (Robert Gordon); “one of the decisive intellectual achievements of postwar economics” (Paul Krugman); “easily the most influential paper on macroeconomics published in the post-war era” (Mark Blaug and Robert Skidelsky). 4 The appeal of the concept is clear: It provides a bridge between the nonmonetary world of intertemporal exchange of economic theory, and the monetary world of credit contracts in which we actually live. In so doing, it turns the intertemporal story from a descriptive one to a prescriptive one — from an account of how interest rates are determined, to a story about how central banks should conduct monetary policy.
To understand the ideological function of R*, it’s useful to look at a couple of typical examples of how it’s used in mediating between the needs of managing a monetary economy and the real-exchange vision through which that economy is imagined.
A 2018 speech by Fed Chair Jerome Powell is a nice example of how monetary policy practitioners think of the natural rate. He introduces the idea of R* with the statement that “In conventional models of the economy, major economic quantities such as inflation, unemployment, and the growth rate of gross domestic product (GDP) fluctuate around values that are considered ‘normal,’ or ‘natural,’ or ‘desired.’” The slippage between the three last quoted terms is a ubiquitous and essential feature of discussions of R*. Like the controlled slipping between the two disks of a clutch in a car, it allows systems moving in quite different ways to be joined up without either fracturing from the stress. The ambiguity between these meanings is itself normal, natural and desired.
In a monetary policy context, Powell continues, these values are operationalized as “views on the longer-run normal values for the growth rate of GDP, the unemployment rate, and the federal funds rate.” Powell immediately glosses this as “fundamental structural features of the economy … such as the ‘natural rate of unemployment’.” Here again, we see a move from something that is expected to be true on average, to something that is a “fundamental structural feature” presumably linked to things like technology and demographics, and then to the term “natural”, which implies that these fundamental structures are produced by some quite different process than the network of money payments managed by the Fed. The term “natural” of course also implies beyond human control, and indeed, Powell says that these values “are not … chosen by anyone”. In the conventions of modeling, such natural, neutral, long-run, unchosen values are denoted with stars, so along with R* there is U* and a bevy of starred Greek letters.
Powell, to be fair, goes on to talk about how difficult it is to navigate by these stars in practice, and criticizes his predecessors who were too quick to raise interest rates based on hazy, imprecise ideas of the natural rate of unemployment. But there’s a difference between saying the stars are hard to see, and that they are not there at all. He has not (or, plausibly, assumes his audience has not) escaped the scholastic and tautological habit of interpreting any failure of interest rate changes to deliver the expected result as a sign that the natural rate was different than expected.
It is, of course true, that if there is any stable relationship between the policy rate controlled by the Fed and a target like GDP or unemployment, then at any particular moment there is presumably some interest rate which would move that target to its desired level. But the fact that an action can produce a desired result doesn’t make it “natural” in any sense, or an unchanging structural feature of the world.
Powell, a non-economist, doesn’t make any particular effort to associate his normal or natural values with any particular theoretical model. But the normal and natural next step is to identify “fundamental structural features” of the world with the parameters of a non monetary model of real exchange among rational agents. Indeed, in the world of macroeconomics theory, that is what “deep structural parameters” mean. In the usage of Robert Lucas and his followers, which has come to dominate academic macroeconomics, structural parameters are those that describe the rational choices of agents based only on their preferences and the given, objective production function describing the economy. There’s no reason to think Powell has this narrower meaning in mind, but it’s precisely the possibility of mapping these meanings onto each other that allows the “natural rate” and its cousins to perform their ideological role.
For an example of that next step, let’s turn to a recent report from the Centre for Economic Policy Research, which assembles work by leading European macroeconomists. As with Powell’s speech, the ideological understanding of the natural rate is especially striking here because much of the substantive policy argument being made is so reasonable — fiscal policy is important, raising interest rates makes public debt problems worse, the turn to austerity after great financial crisis was a mistake.
The CEPR economists begin with the key catechism of the real-exchange view of interest: “At its most basic level, the interest rate is the ‘price of time’ — the remuneration for postponing spending into the future.” R*, in other words, is a rate of interest determined by purely non monetary factors — it should be unaffected by developments in the financial system. This non monetary rate,
while unobservable … provides a useful guidepost for monetary policy as it captures the level of the interest rate at which monetary policy can be considered neutral … when the economy runs below potential, pushing actual real policy rates sufficiently below R* makes policy expansionary.
The notion of an unobservable guidepost doesn’t seem to have given the CEPR authors any pause, but it perfectly distills the contradiction embodied in the idea of R*. Yes, we can write down a model in which everyone has a known income over all future time, and with no liquidity constraints can freely trade future against present income without the need for specialized intermediaries. And we can then ask, given various parameters, what the going rate would be when trading goods at some future date for the same goods today. But given that we live in a world where the future is uncertain, where liquidity constraints are ubiquitous, and where a huge specialized financial system exists to overcome them, how do we pick one such model and say that it somehow corresponds to the real world?
And even if we somehow picked one, why would the intertemporal exchange rate in that world be informative for the appropriate level of interest rates in our own, given that the model abstracts away from the features that make monetary policy necessary and possible in the first place? In the world of the natural rate, there is no possibility for the economy to ever “run below potential” (or above it). Nor would there be any way for a single institution like a central bank to simultaneously change the terms of all those myriad private exchanges of present for future goods.
Michael Woodford, whose widely-used graduate textbook Interest and Prices is perhaps the most influential statement of this way of thinking about monetary policy is, unusually, at least conscious of this problem. He notes that most accounts of monetary policy treat it as if the central bank is simply able to fix the price of all loan transactions, but it’s not clear how it does this or where it gets the power to do so. His answers to this question are not very satisfactory. But at least he sees the problem; the vast majority of people using this framework breeze right past it.
The CEPR writers, for instance, arrive at a definition of the natural rate as
the real rate of interest that, averaged over the business cycle, balances the supply and demand of loanable funds, while keeping aggregate demand in line with potential output to prevent undue inflationary or deflationary pressure.
This definition simply jams together the intertemporal “interest rate” of the imagined non monetary world, with the interest rate target for monetary policy, without establishing any actual link between them. (Here again we see the natural rate as the clutch between theory and policy.) “Loanable funds” are supposed to be the real goods that their owners don’t currently want, which they agree to let someone else use. The “while” conjunction suggests that clearing the loanable-funds market and price stability are two different criteria — that there could in principle be an interest rate that keep output at potential and inflation on target, but failed to clear the market for loanable funds. But what could this mean? Are there any observable facts about the world that would lead a central bank to conclude “the policy rate we have chosen seems to be consistent with price stability, but the supply and demand for loanable funds are not balanced”? Where would this imbalance show up? The operational meaning of the natural rate is that any rate associated with the macroeconomic outcomes sought by the central bank is, by definition, the “natural” one. And as Keynes long ago pointed out — it is a key argument of The General Theory — the market for loanable funds always clears. There is no need for a market price balancing investment and saving, because any change in investment mechanically produces an exactly equal change in saving.
In practice, the natural rate means just this: We, the central bank, have set the interest rate under our control at a level that we hope will lead to our preferred outcomes for GDP, inflation, the unemployment rate, etc. Also, we can imagine a world in which rational agents trade present goods for future goods. Since in some such world the exchange rate between present and future goods would be the same as the policy rate we have chosen, our choice must be the optimal one.
- See the thorough discussion in Arie Arnon’s superb book on the history of monetary theory.
- Kocherlakota’s views have, of course, evolved considerably since then.
- Actually, in most contexts where the natural rate of interest comes up, the existence of a financial system beyond the central bank is simply ignored. This is an important analytic cost of the natural rate framework, a point we’ll return to.
- All quotes from Snowdon and Vane, Modern Macroeconomics: Its Origins, History and Current State.
I think that the concept of the “natural” interest rate as a result of intertemporal preferences implies the idea that there is a fixed savings/nominal income (or wealth/income) ratio, that represents aggregate saving preferences (I think); and on the other hand the existence of a fixed capital/output ratio.
Both these assumptions are dubious to say the least: on the fixed wealth/income ratio we can see empitically that in reality it grows during the business cycle and then collapses during recessions (and in recent decades there is a clear tendence to the increase of the wealth to income ratio:
https://wid.world/world/#wwealn_p0p100_z/US;FR;DE;CN;ZA;GB;WO/last/eu/k/p/yearly/w/false/165.10199999999998/1000/curve/false/country
).
On the fixed capital/output ratio, since in pratice we are making a ratio of the vaule of capital goods and output goods, it only makes sense if we assume that the relative prices of capital goods and output goods is somewhat fixed by technology, that would lead us to a Sraffa world o a LTV world, not to the marginalist world in which these thweories are supposed to work.
Even in a Sraffa world or LTV world, some capital goods (e.g. natural resourrces like land or energy, or bottlenecks in distribuition etc.) are bound to be inelastic in terms of supply, which means they’ll react in terms of prices, which means that the wealth/income ratio can’t be technologically fixed: it only can be fixed if we assume that there is a well defined “full employment of all resources” situation, and then in that situation, given the well defined values of wages and income and capital assets, one could calculate a natural interest rate (that is, not averaged during the cycle but only at this supposed full employment of all resources situation).
But if the economy could really reach this mystical full employment of all resources, by definition the economy could not grow anymore, so there could not be positive net investiment, so the interest rate could only work for intertemporal preferences about consumption goods, which doesn’t work either unless you expect people to run down all their savings just before their death.
But as a matter of fact the interest rate is supposed to match savings to net capital investiment, so logically at full employment of all resources it should be 0, because additional investiment is impossible.
My understanding of Sraffa (which is not very deep or very current) is that the big takeaway is that it is impossible to derive an interest rate or rate of profit from the physical conditions of production. We have to already have an interest rate/profit rate (equivalent for him, I guess) before we can know what the tradeoff between current and present consumption even is.
My general feeling about Sraffa is that the conclusion that we can’t derive orthodox conclusions from orthodox premises may be correct, but it not super helpful since we shouldn’t be starting from those premises in the first place.
I made a very confused argument because I mixed up various things, I’ll try to explain my point(s) in a more ordered way:
The idea of a natural rate of interest is based on the idea of a natural rate of profits. There are some problems both with the idea of the natural rate of interest and more generally with the natural rate of profit.
Speaking only of interest and the money economy, a stable rate of interest can only exist if the ratio between savings and income is fixed: if at full employment GDP is 100$/year, and total savings are, say, 500$, then we have a stable savings/income ratio, presumably also a wealth/income ratio, and then we can have a stable interest rate.
But if at full employment people still want to accumulate savings, since total income cannot go up because we are at full employment, the savings/income ratio has to go up, potentially indefinitely; therefore the interest rate has to fall indefinitely because otherwise interest would eat out all of GDP.
So there is the question of whether there is something like a natural level of savings, or whether people just try to go on saving until the system is too leveraged (very high savings/income ratio) and a small unexpected change in prices can cause a financial collapse.
I take this to be a different formulation of Minsky’s theories.
But then, if we assume that savings/wealth represent in some way the value of capital goods, and so enter in the realm of the “real” economy, the problem only becomes worse:
The average rate of profit is aggregate profits/aggregate capital.
Aggregate profits are total net output multiplied the profit share, or (1- wage share).
So average profits are:
P = (total value of net output)(1- wage share)/(total value of capital)
In order to have a natural rate of profit we need to have both a natural wage share and a natural capital/output rate, both of dem depending on “technology”.
Sraffa’s critique is that “technology” cannot really determine the wage share, but in my understanding (I might be wrong) the capital/output ratio is fixed in Sraffa’s model, that is basically Ricardo’s “corn model” adapted to a situation where there are many differnt goods whose production is interrelated, so that Sraffa creates a “standard commodity” (that is an index of the interrelated goods) and then when we account things in terms of this standard commodity we go back to Ricardo’s corn model.
If Sraffa’s model was entirely realistic, and if we add the assumption that capitalists are the ones who are saving, since the capital to income ratio is fixed the only thing that can change is the wage share, so if the interest rate falls capitalists invest more and unemployment falls until the profit rate falls in line to the desired level of savings of capitalists.
But this is very unrealistic, because first capitalists (or anyone else) do not really have a fixed savings/income target, and also because, we can argue about the reasons of it, but it is evident that the wealth to income ratio is not fixed ant that it tends to go up during the business cycle.
So at some point there is the question of: if there isn’t a target wealth to income ratio due to intertemporal saving prferences (that imply that at full employment aggregate savings are 0, so not very realistic), and if for a reason or the other the capital/output ratio is unstable, is there or can there be a natural wealth to income ratio?
If we go back to the othodox (marginalist) model, I think that the problem is not that you can’t deduce orthodox conclusions from orthodox premises, but rather that, in the intellectual history of economics, economists swapped the conclusions with the premises:
If we assume that there is a natural wealth to income rate, due to technology (the capital/output ratio), and we assume that there is a fixed savings/income target ratio, then the natural interest rate becomes the target for the profit rate, and the wage share moves to accomodate the profit rate to it.
The resulting wage share is then declared as the “marginal productivity of labor”, and the remaing productivity is attributed to capital.
Full employment then is the situation where this target wage share arises (and therefore might be a less than idilliac situation for workers).
This is sometimes rationalised by implying a falling productivity of labor and of capital, but this can only work if we accept that there is a falling productivity of aggregate labor and capital, and thus an implicit malthusian model, that is not in evidence in the real world.
But anyway even this assumes that at full employment people don’t want to accumulate wealth (that in real terms would be impossible at full employment), but in the real world people want to accumulate wealth even at full employment (however defined) so a fixed wealth to income ratio is impossible, and a fixed natural interest rate/profit rate also is impossible, it either has to fall indefinitely due to a denominator effect or a crisis has to happen (this denominator effect, when conceived in terms of real capital, is Marx’ tendency of the rate of profit to fall).
I’m glad to see you attacking this problem, with the usual erudition and wit (“navigating by the (R) stars”—wish I could write like that). Yes, Keynes showed that the loanable funds market (really not a market but the balance between investment and saving) is always in equilibrium—because output adjusts to make it so. But the basic Keynesian model you are critiquing maintains that there is a unique level of output where inflation stabilizes, and the interest rate that achieves it is R*. If you change something, say increase the propensity to save, R* will change; the central bank just has to adapt. The flaw from a structuralist Keynesian point of view seems to me to lie in the assumption that there is a unique inflation-neutral equilibrium level of output. If there is some path dependence, there can be many possible R*’s in a static 3-equation type model, i.e. multiple equilibria. In which case, monetary policy that for example tries to reverse the hysteresis effects of a negative shock like the GFC will wind up affecting R* by targeting a different position on the IS curve than would prevail if they just followed business as usual. (I have a joint paper in ROKE on this.) But I can also imagine (and have written) models in which monetary policy does not have that power, even though it can affect the path of output and employment permanently. So not sure R* is the only thing to worry about. A lot depends on how you model the inflation barriers—I wish I had a definitive answer. I think in your larger project with Arjun it might be useful to separate the critique of mainstream models from your own positive model or models? It would be nice to have something that corrects the incoherent MMT assertion that you can just set the interest rate below the growth rate and solve the problem of national debt. A vigorous debate among progressive economists on this would be salubrious, IMHO.
Thanks for comment. Also, I just read the short paper you sent me a month ago and liked it very much. Will have comments to you shortly.
The flaw from a structuralist Keynesian point of view seems to me to lie in the assumption that there is a unique inflation-neutral equilibrium level of output.
That’s one flaw for sure. But there’s another flaw, or maybe a more general flaw of which yours is a specific example, which is the step from the existence of a (unique or otherwise) policy interest rate that is consistent with target inflation under a particular set of conditions, and the intertemporal interest rate associated with “deep structural” supply-side characteristics like population growth, the rate of technological change, rate of time preference, etc. The assertion that the two are in some sense equivalent is ubiquitous, but I’ve never seen it actually defended. And it leads to all sorts of wrong conclusions, like that the “natural” or “neutral” rate can be defined independently of other factors influencing demand, like the fiscal position, or other factors influencing credit conditions besides the policy rate.
So not sure R* is the only thing to worry about. A lot depends on how you model the inflation barriers—I wish I had a definitive answer.
Yes, the other big question in this space (imo) is how to think about supply constraints.
I think in your larger project with Arjun it might be useful to separate the critique of mainstream models from your own positive model or models
Yes. I’d really like the book to be mostly making positive arguments, and only the minimum of critique of the mainstream. But it’s hard to get away from.
“The assertion that the two are in some sense equivalent is ubiquitous, but I’ve never seen it actually defended. And it leads to all sorts of wrong conclusions”
– The official answer would be that short-run r* (the policy interest rate consistent with target inflation given current conditions) and medium or long-run r* are conceptually distinct. People may then argue that long-run r* is determined by “deep structural parameters”, will equal the prevailing policy rate on average, etc., while short-run r* doesn’t have these properties. In Interest and Prices Woodford made a point of arguing that the short run natural rates of interest and output move around at business-cycle frequencies for reasons described by real business cycle theory. In particular fiscal policy would move short-run r*. (And other people can argue long run r* is not determined by deep structural parameters etc.)
As you describe, an annoying feature of contemporary macro is that the same terms are used to mean different things – so in practice r* can be used interchangeably to mean a short run or a long run concept, the long run average of observed interest rates, something that would arise in a flexible price model, etc. I think the least worst approach is to focus on short-run r* as you define it (“It is, of course true…”) – to ask what level of the policy rate, unemployment rate, etc. would be consistent with target inflation, all else equal, over the relatively near term. That is the entity that has the best chance of actually existing.
People may then argue that long-run r* is determined by “deep structural parameters”, will equal the prevailing policy rate on average, etc., while short-run r* doesn’t have these properties.
But again, I don’t see any reason to think that the characteristics of real economies that have some kind of representation in non-monetary models (like production technology or laborforce growth) are in any sense more structural than factors like the fiscal balance, the trade balance, the degree to which various units and transactions are liquidity-constrained, etc. Everything we know about the world suggests that the latter variables are no faster-moving than the former ones.
In Interest and Prices Woodford made a point of arguing that the short run natural rates of interest and output move around at business-cycle frequencies for reasons described by real business cycle theory.
Interest and Prices is a tour de force in constructing a story that both respects the conventions of the formal-modeling game and yields optimal policy that superficially resembles what central banks actually do.
ask what level of the policy rate, unemployment rate, etc. would be consistent with target inflation, all else equal, over the relatively near term. That is the entity that has the best chance of actually existing.
I agree that’s less bad, but it’s still not great. Among other things, it makes the choice of a policy interest rate look like a fundamental parameter of the economy, rather than just the instrument central bankers have chosen to use recently. (Or more precisely, the way that central bankers have chosen to talk about their activity recently.)
In the plain vanilla new keynesian model it happened to be the case that the steady-state real interest rate in the flexible price version of the model did not depend on the fiscal balance (or on the trade balance or liquidity constraints because these did not exist in the model). So, even if e.g. the share of government purchases or transfers in GDP shifted to a permanently higher level, that would not move long run r* in this particular model.
In later descendants of the NK model (e.g. the secular stagnation models) long run r* indeed depends not just on ‘deep structural parameters’ but also on fiscal policy, liquidity constraints, safety and liquidity premia, etc. Indeed the CEPR report proposes various policies to increase r*! In these situations, you are right, calling it a `natural’ rate of interest is misleading. You are also right that the default model macroeconomists go to *is* one where long run r* depends on preferences and population/tech growth, and defaults still shape people’s thinking even though if there are exceptions to the default buried in some journal.
“It would be nice to have something that corrects the incoherent MMT assertion that you can just set the interest rate below the growth rate and solve the problem of national debt. ”
If you need to criticize MMT at least get the facts right. Most MMT economists say the government should not issue debt when it spends. If for some reason the government desires to issue debt, then the interest rate should be allowed to fall to zero and remain there. The MMT conclusion is that in the absence of central bank actions to maintain positive interest rates, deficit spending by the currency issuing government will result in excess bank reserves that will cause the inter-bank loan rate to fall to or near zero. You might disagree with that assertion, but it is not incoherent.
And there is no problem with the national debt that needs to be solved. Really- has it been a problem for you or anyone you know?
Sorry, poor choice of words. I don’t think it makes sense to abandon monetary policy and assign all the burden of stabilizing demand to fiscal policy. Why throw away the option of using a policy mix, for example? I have not found anything in Mitchell et al’s text or Kelton’s book that persuades me. Also, agreed: debt isn’t currently a problem. But in the long run, it has to be managed.
I got a laugh out of the unobservable but somehow supposedly useful ‘guidepost’ for policy. Thanks.
The never ending battle of ideas on the interest rate that is evident between classical/neoclassical theory and Keynesian theory is destined to be unresolved.
The problem is that the first set of theories generally assume full employment of resources and a fixed level of income while the latter deals with the situation where income is not fixed and in fact is the major variable.
The first set of theories deal with the allocation of scarce resources (i.e. scarce savings and capital goods) and relative prices. The latter deals with levels of spending.
If the dichotomy is recognized, the theories can be reconciled.
That’s part of the difference, but I don’t think it is *the* difference. The difference between a real-exchange vision and a Minskyan balance-sheet vision of the economy goes beyond whether or not you think there is normally unused capacity in some sense.
Josh,
I haven’t studied Minsky closely so I am not precisely sure what you mean by a Minskyan balance sheet vision. It sounds like some sort of stock-flow consistent approach?
Re your point, even Keynes, in the dying pages of the GT, asserted that at full employment of resources the classical approach was valid, the corollary being that at anything less than full employment, his approach was valid.
If it’s not “the” difference how would you, briefly, characterize it?
Yeah Henry, Keynes was a pretty smart guy. I think he is right about how he could say -Yes ,in the ideal situation you guys are completely correct, but since we are not in that ideal situation 99.9% of the time, well, those are the times I am correct.
I’d rather be in that 99.9% of the time right.
But then I am not completely sure that the other guys were right even .1% of the time.
“…whether or not you think there is normally unused capacity in some sense…”
Where there is unused capacity, optimization is irrelevant and changes in relative prices ineffectual.
Where there is full employment of resources, more spending will have minimal real effects, its main impact on inflation.
Income and wealth distribution effects result from relative prices effects and impact the macroeconomy via level of spending effects.
In an open economy, relative prices and the level of spending are both at play.
In a mixed economy, government spending pertains largely to the level of spending mode. Taxation has both relative prices and level of spending effects.
All manner of economic forces fit into either a relative prices mode or level of spending mode.
I can’t see that there is any other difference to be considered.