Post Keynesian Policy on Interest Rates

I know I have posted this video before (over a year ago), but, in light of recent discussion on the blog comments section on interest rates, I think it deserves to be posted again, since it is a very clear and useful overview of the Post Keynesian policy on interest rates.

First, one should note that this is a summary of what modern Post Keynesianism says about interest rates, not necessarily Keynes himself. Keynes is sometimes charged with having left an ambiguous element in his General Theory, by which he did not sufficiently stress the role of uncertainty and expectations in undermining the coordinating role of interest rates (King 2002: 14). In Chapter 18 of the General Theory, Keynes played down the role of uncertainty (which he had stressed in Chapter 12) and, if he had really maintained the crucial role of uncertainty (as he did later in Keynes [1937]), this would have “ruled out any stable functional relationship between investment and the interest rate” (King 2002: 14). The door was thereby left open for neoclassical synthesis Keynesians to reformulate the General Theory as a general equilibrium model where the interest rate has a pivotal role (King 2002: 14).

But to return to the main point, there are two traditions within modern Post Keynesian economics on the role and effect of interest rates:

(1) the activist Post Keynesians (Basil Moore [1988], Giuseppe Fontana, Thomas Palley), who, instead of an inflation target, advocate activist monetary policy as a useful tool for targeting output, investment or capacity utilization;

(2) the group Rochon calls the “parking it” Post Keynesians, who contend the fiscal policy is the main tool to target output, employment and investment, while monetary policy comes with disturbing side effects on real variables. The relationship between interest rates and output is complex and not linear: the monetary transmission mechanism between interest rates and real economic variables is unreliable and complicated. The interest rate should be parked at a given level and fiscal policy should be employed. There are three further subdivisions within the “parking it” Post Keynesians:

(i) the Smithin rule: the real rate of interest should be very low, close to zero (John Smithin);
(ii) the Kansas city rule: the nominal rate of interest should be zero, possibly negative real rates of interest (Wray, Matthew Forstater, Pavlina Tcherneva).
(iii) the Pasinetti rule/Fair Rate rule: the real rate of interest should be equal to the rate of growth of labour productivity (Pasinetti).

My feeling is that the “parking it” Post Keynesians are essentially right. Notably, some of Basil Moore’s policy ideas have seemed quite controversial to other Post Keynesians, and even to concede too much to neoclassicals (King 2002: 176, 178).

Investment is driven to a great extent by expected profitability and expected growth of sales. Interest rates are overrated as an inducement to investment (Arestis 1992: 104), because expectations complicate matters, and pessimistic expectations can shatter demand for credit and investment, even if interest rates are very low. Even attempts to reduce investment in some predictable or consistent way by means of interest rate rises historically show variable results, ranging from little effect to the inducement of recession (Lavoie 1992: 187). (Of course, nobody denies that very drastic increases such as, for example, during the Volcker shock have severe effects on output and employment.) The evidence shows that credit controls have a much more effective influence on economic activity than interest rate changes (Lavoie 1992: 188–189; King 2002: 179).





UPDATE
Philip Pilkington discusses the role of interest rates here in a great post, with additional comments on Kaldor’s view of interest rates and the possible destabilising influence of monetary policy:

Philip Pilkington, “Monetary Policy and Metaphysics – How Economists Try to Naturalise Terrible Policies and Disappear into their own Theories,” Nakedcapitalism.com, December 5, 2012.

BIBLIOGRAPHY

Arestis, Philip. 1992. The Post-Keynesian Approach to Economics: An Alternative Analysis of Economic Theory and Policy. Edward Elgar Publishing, Aldershot, Hants, England.

Keynes, J. M. 1937. “The General Theory of Employment,” Quarterly Journal of Economics 51: 209–223.

King, J. E. 2002. A History of Post Keynesian Economics since 1936. Edward Elgar Publishing, Cheltenham, UK and Northampton, MA.

Lavoie, Marc. 1992. Foundations of Post-Keynesian Economic Analysis. Edward Elgar Publishing, Aldershot, UK.

Moore, B. J. 1988. Horizontalists and Verticalists: The Macroeconomics of Credit Money. Cambridge University Press, Cambridge and New York.

Rochon, Louis-Philippe and Matias Vernengo (eds.). 2001. Credit, Interest Rates, and the Open Economy: Essays on Horizontalism. Edward Elgar Pub., Northampton, MA.

Rochon, Louis-Philippe and Sergio Rossi (eds.). 2003. Modern Theories of Money: The Nature and Role of Money in Capitalist Economies. Edward Elgar Pub, Cheltenham.