(article by Mike, reprinted from Modern Monetary Realism)
Nope, it’s not done yet, wh10!
A few people have been asking for background on the Natural Rate of Interest. Here is something which might help a bit.
The Natural Rate Defined
There are lots of different meanings for the words natural rate of interest. For the purposes of this extended rant reasoned critique, I am using this meaning provided by Roger J Ferguson (2003)of the Fedearal Reserve.
“One way of providing that benchmark is to consider what level of the real federal funds rate, if allowed to prevail for several years, would place economic activity at its potential and keep inflation low and stable. “
Here is more on the Natural Rate from Anderson 2005:
In general, the natural or equilibrium rate of interest is taken to be the real (not the nominal or “money) rate of interest which keeps inflation at a low or zero rate.
“Most central banks now implement monetary policy by setting a near-term target for an overnight interbank interest rate. In turn, policymakers face the difficult issue of how to choose, and adjust, the target rate. One widely discussed policy guide is the “natural,” or equilibrium, real rate of interest.
To use this guide, one compares the level of a medium-term financial-market real interest rate—such as the yield on a 10-year Treasury inflation-indexed bond—to an estimate of the long-term “natural,” or equilibrium, rate of return on the economy’s capital stock. The idea that inflation will be approximately constant when these two rates of return are equal is an extension of an idea advanced in 1898 by the Swedish economist Knut Wicksell.”
Here is a quote from Wicksell, featured as the first words of Michael Woodford’s classic “Interest and Prices”
“If it were in our power to regulate completely the price system of the future, the ideal position . . . would undoubtedly be one in which, without interfering with the inevitable variations in the relative prices of commodities, the general average level of money prices . . . would be perfectly invariable and stable.
And why should not such regulation lie within the scope of practical politics? . . . Attempts by means of tariffs, state subsidies, export bounties, and the like, to effect a partial modi?cation of the natural order of [relative prices] almost inevitably involve some loss of utility to the community. Such attempts must so far be regarded as opposed to all reason. Absolute prices on the other hand—money prices—are a matter in the last analysis of pure convention, depending on the choice of a standard of price which it lies within our own power to make.”
The title of the book, “Interest and Prices”, is an homage to the 1898 book by Wicksell of the same name. So we will be addressing problems with this usage of the term “natural rate of interest” as a real rate of interest which keeps price levels perfectly invariable stable.
The Natural Rate and Central Bank Policy
As the quote from Anderson 2005 shows, this natural rate of interest is widely discussed as being the optimal or target rate for central bank policy. It’s widely accepted the U.S. Federal Reserve and many central banks seem to follow a Taylor rule to guide monetary policy.
Additionally, the opening quote of the enormously influential “Interest and Prices” by Woodford is about the equilibrium rate which keeps prices stable.
The Taylor rule uses an “equilibrium interest rate” as one of the inputs. This is widely accepted to be the same as what I am calling the NRoI.