Tuesday, March 12, 2013

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).

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.


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.


  1. I agree that the rate of interest has a minor effect on investment decisions by firms, but the effect on consumer credit, particularly mortgages, is much greater. In the UK, for example, a cut in the interest rate reduces the mortgage payments made by millions of home owners (increasing their spending power), while making new loans for affordable.

    1. Over 50% of mortgages are on a fixed rate.

      A reduction in interest rates reduces the income of savers by an equivalent amount - which are less likely to be on a fixed rate.

      Interest rates just play the propensities in an uncertain distributional manner with uncertain time lag.

      It's a highly inefficient and ineffective way of controlling anything. Like trying to steer a car by altering the weight distribution between the near and kerbside.

    2. Fixed rates mortgages are only available for short durations in the UK, typically around 2-3 years. And the point about lower interest rate making credit more affordable stands - people can afford to borrow more. As for savers, getting more interest on a long-term savings account is unlikely to increase their spending by much. If such savings are withing a pension plan they cannot be accessed until retirement.

    3. Reducing interest on savings causes people to feel insecure about the future and therefore to save more - offsetting the people who feel they can borrow more.

      As I said you are playing with beliefs about the propensities. All the evidence I've seen shows it is all over the place with all sorts of differing time lags. And it changes based on feedback from the rest of the economy and expectations.

      This is what we mean by uncertain distribution characteristics.

  2. To put a political spin on it. An essential part of Monetary policy is to stabilize the financial system. The idea here is to make sure that investors have capital and that the banks are well capitalized so as to ensure financial stability. While it may be an effective tool, it only helps an unregulated system gain higher dividends. Monetary policy, in the form we have it now, simply props up the neoliberal model. Look at Draghi in Europe, his bond-buying program bought the Eurocrats time to continue to avoid catastrophe.

    On the other hand, fiscal policy does not only stabilize. It re-energizes and re-coordinates economic activity. A Government, while it is a planning entity, when it builds a road or public works at a time of recession, coordinates economic activity around that sructure. IN that sense, it is only helpful that new information, such as the knock-on-effects of public works and new infrastructure, inform new investments

  3. There's one approach that Rochon misses: what I call the Kaldor approach. This is about the use of interest rates in full employment regimes to counteract swings in inventory accumulation. It is often forgotten because, since Kaldor had written about it in the 1950s, idiotic policymakers have ensured that we never really reach full employment. The Kaldor approach is dealt with at the end of this piece:


    Oh, and as I pointed out in the other thread, Keynes explicitly states that interest rates had uncertain effects in his critique of Tinbergen.

    1. Your post is insightful, and there's certainly a gap above in my treatment of interest rates. I've neglected Kaldor's views on interest rates and inventories.

    2. In fact, I've updated with a link above to that post.

  4. Thanks for posting this. I found the following link that (i think) covers the same ground).


    If I understand what Rochon is saying then his model is based on the following main assumptions:

    - The interest rate is mainly a distributional tool for how profits are shared between businesses and "rentiers"

    - The lower the interest rate the greater the share retained by business and the greater the growth rate in the economy

    - Wage increases will be inflationary if not matched by increases in growth so the higher the rate of growth the lower the inflation rate (other things being equal)

    Based on this he concludes that the lower rate of interest (ideally a nominal rate of zero as suggested by the Kansas guys) the lower the rate of inflation and the higher the rate of growth.

    I know this is probably an oversimplification (the math is pretty heavy-duty and he distinguishes between different stages in the economic cycle, and I have simplified what he said about wage growth)) - but is the above roughly correct ?

  5. Good interview with Steve Keen on margin debt and the stock market bubble.


    I must admit, what he says makes me want to pull out of stocks gradually over this year.

    1. Yep, another good call from Keen. I have posted this video on the latest post.


  6. You'll like this, LK:


    Looks like I was beaten to the punch by Kaldor!

    1. Jan: Ha ha, Philip,it´s no shame to be beaten to the punch by Kaldor :) ,a true genuios!He has been a long time inspiration for me to.And thanks LK!This is a splendid article!! Cheers!

  7. A common theme among Post-Keynsians on interest rates is the need to "euthanize the rentiers". A low or zero interest rate would help achieve that by cutting off income to this group of society and reducing the incentive to anyone who might otherwise be tempted to save out of current income and join this group.

    I assume that for post-Keynesianism this throttling of savings is a good thing since it reduces the possibility of savings ever being too high for full employment to be achieved. However since Keynsians also believe that fiscal policy can be used to achieve full employment at any level of interest rates and savings I think this "euthanize the rentiers" stuff must be as much political as economic.

    Can I suggest a post that explicitly address the "euthanize the rentiers" theme? I suspect this would highlight some of the main differences between Post-Keysians and other schools of thought.

    1. "I think this "euthanize the rentiers" stuff must be as much political as economic."

      I think I can see your problem.

      Economics is politics. Trying to pretend that it isn't is a political act.

      The 'schools of thought' are all political positions based upon a belief in the way society should be organised.

    2. I think it is important to separate out 1) understanding how things work from 2) using that knowledge to achieve desired ends

      I think it would indeed be a problem to start with the assumption that economics is politics. I think that is a view shared by Rothbardian Austrians and Post-Keynsians - which probably explains a lot.