Keynes and the ‘natural’ rate of interest

6 January, 2018 at 11:47 | Posted in Economics | 1 Comment

Keynes’s signal contribution was to switch the emphasis from interest rate adjustments to changes in income as the key macroeconomic adjustment mechanism. In so doing, he argued that the interest rate and asset prices adjust to clear balance sheets incorporating stocks, not flows, of financial claims. He pioneered national income accounting which now reveals the importance of leakages due to business saving, taxes, and imports.

el2003-32aHe also invented a macroeconomic sociology of stagnation in which bear speculators forced interest rates to be high in the bond market and high saving “rentiers” held down demand. Today, the wealthy benefit from a big share of profits in GDP based on political wage repression. These profits are more than transferred to households by interest, dividends, and capital gains (with the latter mostly flowing to the rich). Bond price bulls replaced bears. They are supported by low interest rates from the Fed and arguably the RoW savings glut. There has been a realignment of the classes since Keynes’s day, but his insight that capitalism favors the rich and tends toward stagnation remains valid.

Writing in the General Theory after leaving his Wicksellian phase, Keynes said that “I had not then understood that, in certain conditions, the system could be in equilibrium with less than full employment … I am now no longer of the opinion that the concept of a ‘natural’ rate of interest, which previously seemed to me a most promising idea, has anything very useful or significant to contribute to our analysis (pp. 242-43)” …

Today’s New “Keynesians” have tremendous intellectual firepower. The puzzle is why they revert to Wicksell on loanable funds and the natural rate while ignoring Keynes’s innovations. Maybe, as he said in the preface to the General Theory, “The difficulty lies, not in the new ideas, but in escaping from the old ones… (p. viii).”

Lance Taylor


1 Comment

  1. “Today, the wealthy benefit from a big share of profits in GDP based on political wage repression.”

    Far more wealth is generated in the world financial sector, that is not counted by GDP. Bain & Company estimates world capital at $900 trillion by 2020, and they are likely being conservative. BIS statistics show OTC derivatives alone at half a quadrillion dollars.

    Bain link:
    BIS statistics link:

    Also, consider Tarullo in

    “Daniel Tarullo, who left the US central bank’s board of governors earlier this year, said economists displayed a paradoxical faith in the usefulness of unobservable concepts such as the natural rate of unemployment or neutral real rate of interest, even as they expressed doubts about how robust those concepts were.”

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