Chapter 6: Money, Interest Rates and Output
THE NATURAL RATE OF INTEREST As illustrated in Chapters 4 and 5 above, although economists of a wide range of opinion can accept (to a greater or lesser degree) that monetary policy will be non-neutral in the short-run due to nominal rigidities, this need not compromise the still more deeply held belief that purely monetary factors will not aﬀect the ultimate long-run equilibrium, or growth path, of the economy. The basis of the latter position is the idea that the rate of interest, at its most fundamental level, is a ‘real’ rather than a monetary phenomenon. Hence, almost by deﬁnition, it cannot be permanently aﬀected by the activities of central banks. We are asked to imagine that in principle a rate of interest exists which represents the outcome of the ‘true’ motives of borrowers and lenders as these would be revealed if they could somehow interact in a capital market operating without the intervention of money, banks or other ﬁnancial institutions. This is what Wicksell (1898a, 1898b) called the ‘natural rate of interest’, although the basic idea long antedates Wicksell’s contribution. The next step in the argument is to assert that the real-world complications caused by the actual existence of money and banks do not, in fact, have any lasting impact on the motives of those engaged in the supposedly more fundamental barter capital transactions. The natural rate as established by the imaginary barter transactions is then taken to be the most basic determinant of the complex...
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