Jonathan Catalán, “A Thought on the Business Cycle, Economic Thought,” Economic Thought, 8 March, 2013.My immediate question is: in previous posts, Catalán implies that he does not think that there is a real world tendency towards a general equilibrium (GE) sstate, whether towards a Walrasian GE or Mises’s “final state of rest” (although the actual equilibrium state is never attained, of course).
Yet the Hayekian ABCT requires a “transition between equilibria” - that is, a real world tendency towards an equilibrium state for the theory to work.
But there is a gaping hole here: if you do not think that real-world market economies have a tendency towards a general equilibrium state, then what is the use of the theory?
The Hayekian ABCT is just another equilibrium theory, and once one accepts that equilibrium theory is irrelevant for the real world, it follows logically that any ABCT that requires and posits a “transition between equilibria” in real market economies is also irrelevant.
Which, stated differently, says: the natural rate of interest does not exist.ReplyDelete
The natural rate of interest arises out of the attainment of the general equilibrium conditions. It is, as we often say, a residual. If these general equilibrium conditions do not exist then neither does the natural rate of interest.
Okay, but general equilibrium conditions do exist -- inside economists' heads. And so, the natural rate of interest also exists -- inside economists' heads. They both exist as thought experiments that have no corollary in the real world which is much more complex than the restrictive models and is subject to disequilibria that arise out of the mechanisms that economists think generate equilibria (think debt deflation, for example, and all the other so-called "paradoxes" of the General Theory).
So, the question: what is the natural rate of interest? Answer: it is a metaphysical entity.
Makes you wonder why the natural rate of interest hasn't become an anthropormorphic personification.Delete
That's generally what happens to metaphysical entities.
Haha! But it HAS, Neil! The Central Bank claims to target it. So, multiple economists waste their time trying to estimate it using econometric models. They then carry the estimations to Open Market Committee and try to force the short-term interest rate into lines with the natural rate. Ben Bernanke IS the natural rate -- at least, that's what he and those around him believe.Delete
The Central Banks are more Austrian than the Austrians, but because the latter don't understand modern New Consensus Macroeconomic theory they don't recognise it.
New Consensus Macroeconomics: How I Learned to Stop Buying Gold Bullion and Love Ben Bernanke.
And all will become clear. As I said in the latter:
"Models such as the ISLM – nearly all economic models, really – are self-justifying. One could say that they are almost tautological constructions. What they seek to do is dissolve the conceptions of the world held by the model-user into the models themselves. Buried deep within the model, most students don’t question these assumptions at all. They just assume that the world is as the ISLM says it is, while in truth the world is simply run by folks who think that the ISLM is a good representation of that world and thus a good guide to policy."
Replace the term "ISLM" with "natural rate of interest" and you'll see what these theories are really all about.
Yes, the "neutral rate of interest" is just the modern neoclassical version of Wicksell's natural rate.Delete
I have a question for those who believe the natural rate of interest does not exists.ReplyDelete
Assume an economy with a specific set of physical goods, production processes, prices, and expectations held by the participants about the future state of these various things.
Would you believe that there would be an optimum rate of interest for that economy ?
If yes: How would this optimum rate differ from the natural rate?
If no: Are you saying that it makes no difference what rate of interest the CB tries to establish in the economy?
(1) define what you mean by "optimum rate of interest for that economy"?Delete
(2) the concept of rate cuts simply inducing more investment is different from a natural rate.
(3) obviously the base rate affects the spread of private bank rates. Yes, obviously it is an economic variable businesses take notice of. Put it too high and you discourage investment and cause spread of private bank rates to soar, with disastrous results (e.g. the Volcker shock).
"I have a question for those who believe the natural rate of interest does not exists."Delete
He says before launching into an irrelevant thought experiment...
These people will never get it. Just give up, dude. You're looking at our fingers, we're pointing to the moon.
For the sake of this discussion I will define it as "the rate that maximizes the possibility of avoiding both unsustainable booms and unnecessary recessions".Delete
If interest rates can indeed induce more or less investment then (assuming that at any given moment there is an identifiable optimum level of investment) there surely there must be an optimum rate.
If there is such a rate: How would it differ from the natural rate ?
The effects of interest rate changes are context dependent and non-linear. End of discussion. If you can't get your head around this, stick to neoclassical economics.Delete
rob@March 9, 2013 at 9:04 AMDelete
"For the sake of this discussion I will define it as "the rate that maximizes the possibility of avoiding both unsustainable booms and unnecessary recessions".
No, the causes of recessions are so complex and varied that interest rates will not do this. Interest rates are a blunt instrument and always have been.
Furthermore, "unsustainable booms" are mostly a fiction of the Austrian economics; they require GE theory - if not an actual GE state - and closed economies.
So I asked a simple enough question "is there or is there not an optimum rate of interest for an economy at any point in time"Delete
And I don't think I got an answer.
In case it was unclear to you, my answer is: there is no such "optimum rate of interest" in the way you define it.Delete
Is there a definition of an optimum rate of interest that you think could exist? If so, what is it ?
Hmm. What we have here is a failure to communicate. On one side, a fetishistic notion of interest rates as the ONE thing that coordinates output level. On the other, a realistic allowance that few people watch interest rates or use them to guide their economic decisions, and that output levels result more from other various factors (I'd guess that astrology charts are more important influences, for instance). The notion of "optimum rate" slips the assumption of a natural rate into the discussion under the covers.Delete
The "best rate" would be a low rate to encourage capital goods investment, make the cost of financial capital low, and even consumer credit low as well (for creditworthy borrowers, that is). E.g., Keynes thought the interest rate should be low.Delete
But, unless you're talking about avoiding sharp rises in the rate as a crude inflation-fighting monetary policy (and you don't seem to be), then such a rate isn't the best thing for minimising recessions.
For that, you need a lot of the other policy instruments, e.g.,
- effective financial regulations (to stop asset bubbles)
- social and economic policies to stop people from being driven into excessive private debt
- fiscal policy
'The "best rate" would be a low rate to encourage capital goods investment, make the cost of financial capital low, and even consumer credit low as well'Delete
Would it be possible in your view to have a rate of interest that was too low ?
Furthermore, "unsustainable booms" are mostly a fiction of the Austrian economicsReplyDelete
The Barber Boom (1972-73) and the Lawson Boom (1986-88) are examples of unsustainable booms in the UK, and are recognised as such my most British economists. In both cases, loose monetary policy led to a temporary surge in growth followed by accelerating inflation.
"The effects of interest rate changes are context dependent and non-linear. End of discussion. If you can't get your head around this, stick to neoclassical economics."ReplyDelete
I think this comment should get a prize for being disrespectful, arrogant and totally meaningless all at the same time.
Maybe its meaningless. Or maybe you don't understand it. Meaninglessness, like beauty, is often in the eye of the beholder. Put differently: the splinter might be in your eye, not in what I wrote.Delete
Here's some reading material for you:
"In other words, a nonlinear system is any problem where the equation(s) to be solved cannot be written as a linear combination of the unknown variables or functions that appear in it (them)... Nonlinear problems are of interest to engineers, physicists and mathematicians because most physical systems are inherently nonlinear in nature. Some aspects of the weather (although not the climate) are seen to be chaotic, where simple changes in one part of the system produce complex effects throughout."
I repeat: the effects of the interest rate are non-linear. Changes in the interest rate produce complex effects throughout depending on what is going on in the rest of the economy.
Non-linearity is only an issue if one requires a mathematical model to understand the effect of interest rates on the economy. Reading an undergraduate textbook in economics indicates that this is not the case.Delete
So: I ask if there is n optimum rate of interest if you "Assume an economy with a specific set of physical goods, production processes, prices, and expectations held by the participants about the future state of these various things"Delete
and you reply that "Changes in the interest rate produce complex effects throughout depending on what is going on in the rest of the economy" plus some waffle about non-linear systems and some dis-respectful comments.
Just seems an odd way to have an discussion about economics. I was just trying to ascertain what your and LKs views on the interest rate was.
"Non-linearity is only an issue if one requires a mathematical model to understand the effect of interest rates on the economy."Delete
No. Its not.
You get "disrespectful" comments because you don't seem able to engage with the debate at all. If you spent half as much time actually trying to understand the terms of the debate as you spent huffing and puffing about the respect you are or are not being shown, you might start getting more "respectful" comments from me as I would no longer have to roll their eyes every time you responded.
I'll try to spell this out clearly, but I suspect I'm just wasting my time and my response will be met with more whining. But I'll try one last time.
(1) I originally stated that the natural rate only exists as a thought experiment and requires assumptions so strict as to make them meaningless in the real economy.
(2) I further pointed out that these assumptions necessarily jettisoned certain disequilibrium dynamics that Keynes and other highlighted.
(3) Recall that the natural rate depends on GE conditions. But if wages and prices adjust to produce these conditions in a downturn, debt deflation will kick in and derail the economy.
(4) This will only NOT happen if you exclude it from your thought experiment a priori. But then you are just engaged in metaphysical fantasising.
(5) What response do you give? Well, you start engaging in a restrictive thought experiment. The VERY THING I was just criticising as metaphysics.
(6) Then you expect me to respond to your thought experiment even though it was this method of theorising I just criticised.
(7) Then you huff and puff and demand respect when I roll my eyes. Free advice: respect is earned. If you show yourself as being unable to debate on the same level as your interlocutors they will grow weary of you very fast and some, like me, will revert to sarcastic comments.
(8) The comment about non-linearity was not "waffle". It was the answer to your question. Just because you can't understand something does not make it "waffle".
Here is Colin Rogers -- author of one the best books on the history of monetary theory,* including the work of Wicksell -- on the natural rate:Delete
"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, 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 at p. 546.
*Rogers, C. 1989. Money, Interest and Capital: A Study in the Foundations of Monetary Theory, Cambridge University Press, Cambridge.
I don't really see how asking a simple question about other people's views on the optimal rate (not the natural rate) of interest is conducting a thought experiment of nay kind.
Anyone who can be bothered to read thru this comments section can see that what you say in your comment is not accurate. Beyond objecting to your tone (which any fair person would probably agree was unwarranted) I've really done nothing in this thread apart from point out that my initially question was not answered (BTW: it now has been by LK).
Anyway, the reason I like this blog is that LK raises some interesting topics and seems prepared to discuss them openly. Life is too short to engage in this kind of unpleasant exchange - so in future I shall simply ignore your comments.
Given the centrality of the natural rate to Keynes own thinking I am surprised that Post-Keynsians question its validity so strongly.
I probably need to read the whole book but the quote you provide from Rogers - that no barter economies actually exists - doesn't really seem relevant to the discussion of the natural rate in a monetary economy (and that would in some - but not all - theories of the natural rate produce the same outcomes as the natural rate in a barter economy).
rob@March 10, 2013 at 11:21 PMDelete
(1) Keynes abandoned Wicksell's "natural rate of interest" in the GT. Don't you know that?
And even his "marginal efficiency of capital" notion -- a replacement for the natural rate, to some extent -- is dismissed as erroneous and unnecessary by a number of modern Post Keynesians (e.g., Robinson and Minsky), and probably rightly too.
(2) "I probably need to read the whole book but the quote you provide from Rogers - that no barter economies actually exists - doesn't really seem relevant to the discussion of the natural rate in a monetary economy"
Do you even know what the "natural rate" is?
It makes no sense unless the economy modeled fundamentally as a barter state
The “natural rate of interest” is a non-monetary theory of the interest rate, and is independent of money and credit (Rogers 1989: 27).
As a single market-clearing rate for the market for real capital goods, it is fundamentally a non-monetary concept.
If you think that keynes rejected the concept of the natural rate then I would welcome your views on Goodspeed's "Rethinking the Keynesian Revolution".Delete
A lot of time seems to be wasted discussing natural rate as a "non-monetary theory of the interest rate". This is partially down To Hayek who chose to frame the issue in that way. While I think it can correctly be viewed this way I don't think it needs
to be - it can also be viewed as the rate that will maintain monetary equilibrium.
That is why I tried to start discussing "optimum rates" on this thread - but that discussion got shot down.
If you are saying that the "natural rate" is now to be interpreted as an monetary equilibrium rate that clears the loanable funds market, even that concept is wrong.Delete
Monetary saving and investment (conducted in money loans) is not coordinated by any monetary equilibrium rate - this is just another fiction.
Maintaining monetary equilibrium is about more than 'clearing the loanable funds market' - its about equilibrating the demand for current and future goods (the originary rate) and expectations about future relative goods valuations.Delete
As you believe "Monetary saving and investment (conducted in money loans) is not coordinated by any monetary equilibrium rate" its clear that we are so far apart on this issue that its hard to know where to go with the discussion.
(though I would be interested in any links that you could provide that would explain what you think does co-inordinate monetary saving and investment)
BTW: The theory behind the natural rate as the "rate that maintains monetary equilibrium" is totally consistent with a "non-monetary theory of the interest rate" as you call it.Delete
They are just two ways of looking at the same thing - one a bit more relevant for a monetary economy.
Non-linearity is only an issue if one requires a mathematical model to understand the effect of interest rates on the economy. Reading an undergraduate textbook in economics indicates that this is not the case.ReplyDelete
No. Its not.
OK. Please specify the non-linear relationship that connects the rate of interest to other economic variables. When physicists and engineers speak of non-linear systems, they actually have a non-linear formula in mind. Unless you can produce a such formula, and justify it, your claim is merely waffle.
Increase the interest rate. Savers get more interest income from T-bills -- more aggregate demand. Borrowers pay back more -- less aggregate demand.Delete
The level of aggregate demand depends upon an external variable -- i.e. the borrower/saver ratio (no, these two things are not mirror images) -- and the whole system depends on income distribution between creditors and debtors. Very complex.
Non-linear. Stop studying Praexology and look at the Flow of Funds...
The reason why it is waffle to say "The effects of interest rate changes are context dependent and non-linear. End of discussion."Delete
Is that this is merely stating the obvious as a way of avoiding the discussion. Its as if in response to a meteorologist raising question about a variable that affects the weather you said "The effects of temperature changes are context dependent and non-linear. End of discussion."
Not terribly helpful.
I've never studied praxeology, just degree level economics.ReplyDelete
(1) If one were to express the relationship you describe in a formula, it wouldn't necessarily be non-linear. The change in aggregate demand caused by a change in the interest rate is the sum of the changes in aggregate spending of borrowers and lenders (linear). The relationship between the aggregate demand of each group and the interest rate is probably non-linear, but could be approximated to linear for a small change in the interest rate. The system does not appear to be non-linear in the sense that engineers and physicists mean.
(ii) The problem you describe (the effect of interest rates on aggregate demand) is something discussed in the standard textbooks. They also emphasize the effect of changes in the interest rate on the quantity of credit extended to borrowers and investment decisions made by firms.
(1) A non-linear system is one that doesn't meet the "Superposition principle" which states:
"In physics and systems theory, the superposition principle, also known as superposition property, states that, for all linear systems, the net response at a given place and time caused by two or more stimuli is the sum of the responses which would have been caused by each stimulus individually. So that if input A produces response X and input B produces response Y then input (A + B) produces response (X + Y)."
Interest rate changes do not have predictable effects on the economic system. I was giving you the interest income example because, when coupled with the usual assumption (that falling interest rates mean higher investment) you start to see the non-linear effects. If interest rates fall and cause a net fall in aggregate demand (through lost interest income) this may have a depressive effect on investment that may or may not offset the stimulatory effect that comes with cheaper credit.
We simply do not know what the effects will be because there are so many variables changing that contradict each other in so many different ways. So, rather than input 'i' (interest rate change) producing effect 'In' (increased investment) as may happen in a linear system, we do not know what effect it will have due to the almost infinite number of complicating factors. Thus the "interest->Investment" relationship does not meet the Superposition principle and is thus a non-linear relationship.
(2) I have never seen a textbook that takes into account the interest income channels. Even the New Consensus models with Taylor Rules do not take these into account. They have some stuff about credit-rationing (I don't know if this has made it down to textbook level or not), but nothing about interest income. Only Godley and Lavoie's models take this into account.
Anonymous said: "When physicists and engineers speak of non-linear systems, they actually have a non-linear formula in mind. Unless you can produce a such formula, and justify it, your claim is merely waffle."ReplyDelete
"The truly nonlinear regime is, even
today, only sporadically modeled and even less well understood."
Makes you wonder who is really talking "waffle" here, doesn't it?
"If interest rates fall and cause a net fall in aggregate demand"ReplyDelete
When has a fall in interest rates ever caused a fall in aggregate demand?
"We simply do not know what the effects will be because there are so many variables changing that contradict each other in so many different ways."
A system with a large number of variables isn't necessarily non-linear. Central banks certainly believe that lowering the interest rate will make aggregate demand higher than it otherwise would have been. Are they all wrong?
"The truly nonlinear regime is, even
today, only sporadically modeled and even less well understood."
This is flat-out wrong (or taken out of context). The movement of a pendulum under gravity is a simple non-linear system with an equation that has been solved. The weather has been modelled as a chaotic non-linear system which is producing increasingly accurate predictions.
You're muddling the arguments completely, like Rob did above and like commenters on here do all the time -- it's really vexing.(Are you one of the same people I've engaged on here before? Your argument style of consistently forgetting what we're talking about so that I have to continuously remind you seems familiar to me. And, thankfully, I haven't encountered it anywhere before...).Delete
I'll try to be brief.
(1) "When has a fall in interest rates ever caused a fall in aggregate demand?"
When interest rates fall the interest income that accrues to savers -- say, holders of T-Bills and other instruments that pay interest -- falls. If this outstrips the amount that debtors are paying in interest on loans then, ceteris paribus, demand will fall.
(2) I didn't say that a large number of variables means a non-linear system. I said that a large number of variables the reaction of which to a change in one variable we do not know will constitute a non-linear system. They're two different statements.
(3) I don't care what central banks think. Slipping that in there is a rhetorical attempt to argue by assertion.
(4) If that is wrong then you know more about non-linear systems than a mathematics professor who wrote a textbook on applied linear algebra. Congratulations Anonymous commenter on LK's blog who holds an economics degree. Your PhD in Mathematics is in the mail.
(5) Just because some non-linear systems have been modeled does not contradict the statement by Professor Olver that many non-linear systems have not been modeled.
Remember, you originally said that I was talking "waffle" because I said that interest rate changes had non-linear effects without laying out a non-linear model. You said that if I didn't set out a non-linear model of interest rates then I was talking "waffle".
Now, I provided the above quote to show you that mathematicians talk about non-linear systems without laying out a formal model ALL THE TIME. In fact, it was a mathematician who told me that my argument about interest rates was essentially that they had non-linear effects in the first place.
"When interest rates fall the interest income that accrues to savers -- say, holders of T-Bills and other instruments that pay interest -- falls. If this outstrips the amount that debtors are paying in interest on loans then, ceteris paribus, demand will fall."Delete
Won't "the interest income that accrues to savers" always equal "the amount that debtors are paying in interest"?
Oh, and anyone interested in Keynes' perspective on the issue of interest rates and linear effects might be interested in the following quote which comes from his rightly famous and influential critique of econometrics.ReplyDelete
Rob and our Anonymous friend will no doubt heroically dismiss this as "waffle" despite the fact that it is still mulled over today by most people working in the field, but then most of us are apparently catching up to their profound understandings of methodology and the nature of linear/non-linear systems, so I'm sure they'll both indulge us our vices of ignorance and "waffle"...
"Prof. Tinbergen explains (p. 25) that, generally speaking, he assumes that the correlations under investigation are linear…one would have liked to be told emphatically what is involved in the assumption of linearity. It means that the quantitative effect of any causal factor on the phenomenon under investigation is directly proportional to the factor's own magnitude. In a parenthesis, on page26, to which the reader is not likely to attach much importance, Prof. Tinbergen does, indeed, mention this in passing. But it is a very drastic and usually improbable postulate to suppose that all economic forces are of this character, producing independent changes in the phenomenon under investigation which are directly proportional to the changes in themselves; indeed, it is ridiculous. Yet this is what Prof. Tinbergen is throughout assuming. For instance, in his example of fluctuations in investment, the assumption of linearity means that if the increase in profits is twice greater in one year than in another, then its influence on the quantity of investment will also be exactly twice as great; and similarly, that the effect on investment of a change in the rate of interest will always be directly proportional to the amount of that change."
There's no need to mail me a PhD in mathematics because I already have one. I am merely a student in Economics and your huffing and puffing on the subject is (1) entirely unconvincing and (2) inconsistent with what's written in standard textbooks written by economics professors.Delete
Your argument about lowering interest rates is entirely unconvincing because it fails to consider the increase in the quantity of credit, which should increase aggregate demand, something again emphasized in the textbooks. My question was "When has lowering interest rates ever lowered aggregate demand?", i.e. I was asking for empirical evidence in support of your dubious theory.
You don't care what central bankers think? Oh yes, they must all be deluded whereas only you know the truth! Economics seems to have a lot of puffed-up characters of your disposition, which does not portray the discipline in a good light.
"nconsistent with what's written in standard textbooks written by economics professors. "Delete
I hate to point this out to you, but those standard textbooks are wrong.
What you just did then is refer to the Bible when it is pointed out to you that the age of the earth is measured in billions of years.
I should have added that mathematicians do not talk about non-linear systems in the way you have "all the time". They prefer to deal with concrete models and equations, but even when these are not available they would try to describe relationships between variables in a quantitative way. You have not described a single non-linear effect in your verbiage about interest rates.ReplyDelete
Stick with mathematics -- because without showing you a sealed-and-delivered proof it seems impossible to penetrate your mind. And ask a few your colleagues if it is morally acceptable to broadly discuss non-linear effects without positing a specific model. If the judgment is overwhlemingly negative then I have a mathematician or two I need to inform of their Sin.
Finally, do take a brief look at central bank competence in many major Western economies over the past three decades. There's this strange trend of housing bubbles followed by massive recessions and stagnation. But then who am I to question their competence -- much less the linear effects of interest rates (which have failed massively during these stagnations to revive investment and consumption)?
You've shown epic patience above.
Here is a good video by Louis-Philippe Rochon confirming what you've argued, e.g., as I paraphrased Rochon, "The relationship between interest rates and output is complex and not linear: the monetary transmission between interest rates and real economic variables is unreliable and complicated."
Come to think of it, this video is so useful and such a great summary of things, I'll post it again!:Delete
"But then who am I to question their competence"ReplyDelete
Who indeed. How dare you question the power of the great and might Oz.
What other possible control system could we have for the currency issuer other than one relying on the natural Wisdom of Solomon capability in every rational agent.