“Wicksell treated the natural rate of interest as a real rate of interest in the sense that it equated the forces of productivity and thrift, as if saving and investment were undertaken in real goods (in natura) …. . Monetary equilibrium was said to exist when the market rate of interest, determined in the market for credit, equaled the natural rate, determined by the real forces of productivity and thrift. Any discrepancy between the market and natural rates produced cumulative inflation or deflation.” (Rogers 2001: 545).This is essentially loanable funds theory. But the trouble with the theory is that it cannot be generalized outside of a one commodity economy:
“The natural rate of interest is a real rate in the sense that it is supposedly determined in a market in which saving and investment are undertaken in natura. However, the fact is that in any but the most primitive economy no such ‘capital’ market exists, and the natural rate of interest, as envisaged by Wicksell and Robertson, does not exist either. The concept of the natural rate of interest is not merely non-operational: it is an abstract special case of no general theoretical significance. It cannot, therefore, provide the theoretical foundations for an operational loanable funds theory of the rate of interest” (Rogers 2001: 546).With the collapse of the mythical natural rate of interest, a central element of the alleged equilibrating mechanism that makes Say’s law work also collapses.
And Austrian business cycle theory (ABCT) also employs the Wicksellian concept of the natural rate of interest. With the invalidity of the concept clear, it follows that ABCT is also invalid. I will have more to say about this in future posts.
Rogers, C. 1989. Money, Interest and Capital: A Study in the Foundations of Monetary Theory, Cambridge University Press, Cambridge.
Rogers, C. 1996. “The General Theory: Existence of a Monetary Long-period Unemployment Equilibrium,” in G. C. Harcourt and P. Riach (eds), A Second Edition of The General Theory, Routledge, London.
Rogers, C. 2001. “Interest rate: natural,” in P. Anthony O’Hara (ed.), Encyclopedia of Political Economy. Volume 1. A–K, Routledge, London and New York. 545–547.