Monday, June 6, 2011

The Natural Rate of Interest: A Wicksellian Fable

The natural rate of interest is a non-monetary theory of the interest rate, and was developed in an influential form by the Swedish economist Knut Wicksell:
“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.


  1. Thank for a nice and interesting blog.Yes it´s true that about Wicksell that he in early year was inspired by Menger as well as Walras and Ricardo and equilibrum,but i thinks fair to say later in life his life as starter of the Stockholm school infact come to similar conclusion that todays post-keynsians! Stockholm school,a very hetorodox, independent but very close to Keynes
    views stockholm school of economics and Wicksell infact refused equilibrium as such and in many sences
    had simiar idees as post-keynsians.You could also in many ways include his student Gunnar Myrdal that developt his idees and could find even more i think similarites to post-keynsian thought in many ways.The most that Wicksell and the Stockholm schoolars were in swedish and therefore hardly known outside Sweden.But as a Swede i read a lot of.

  2. I think my previous comment did not get through.

    Basically, I find your critique vague and not to the point. Of course there are different interest rates based on different risks, time preference, expectations. And if you think you will be paid off in inflated dollars, then of course you are going to try to raise the interest rate.
    Thus, the real interest rate is the nominal minus the inflation rate. Aggregation is simply a simplification for use in models and understanding the economy.

    1. Your accusation of vagueness, though accurate, ignores the context in which a blog exists. Blogs are simply a catologue of statements, each usually very short. The whole point of having a blog is to be vague when you like. Also, the Wickseian differential has nothing to do with figuring out the real interest rate per se, but rather to measure the stability of the financial system. It already assumes rates if interest.