From Krugman, Check Out Our Low, Low (Natural) Rates Via Mark Thoma — whom everyone interested in today’s economic debates should check out daily — Thomas Laubach and John C. Williams of the Fed have a new paper updating their estimates of the natural real rate of interest. For those new to the term, the natural rate is a standard economic concept dating back a century; it’s the rate of interest at which the economy is neither depressed and deflating nor overheated and inflating. And it’s therefore the rate monetary policy is supposed to achieve. Laubach and Williams find that the natural rate has plunged in recent years, and is now very, very low. The particular statistical method they use is reasonable, but in any case — as they document — the result pops out for pretty much any plausible methodology. Basically, we’ve had multiple years of very low rates, with no hint of a runaway boom or an inflationary takeoff, so any reasonable estimate is going to say that these low, low rates are close to (and maybe above) the natural rate. L-W attribute the decline in the natural rate largely to the slowing of potential output, which in turn reflects demography and what looks like a slowdown in technological progress. That’s more speculative. But the low natural rate is as solid a result as anything in real time can be. This in turn tells you several things. It says that all the complaints that the Fed is artificially keeping rates low are nonsense; rates are low because that’s what the real economy wants, and the Fed’s only alternative would be to create a depression. It also casts even more doubt on the wisdom of the Fed’s urge to raise rates. Nothing in the economic situation suggests that rates are too low right now. And don’t tell us that we need to start “normalizing”: all indications are that “normal” has changed a lot since 2008, and trying to set interest rates as if the old normal were still valid is a recipe for very bad outcomes. Finally, if the natural real rate is zero or less, a 2 percent inflation target gives very little room for interest rate cuts to fight recessions. The case for raising the target — which means not raising rates if and when inflation finally creeps up to 2 percent — just keeps getting stronger. In any case, the message about what the Fed should do now is clear: nothing. ----------------- ------------------- ------------------- So is the natural real rate really this low or has the Fed hired two goons to draw some red lines on a graph along with some reasoning to hide the conspiracy- oh yes, the conspiracy that the Fed has lowered rates to pump up the stock market to create the illusion that the economy is fine. What say you?
Fed manipulating doesn't do anything but skew things... The natural rate of interest is something that exists outside of the fed... Fed trying to control has the effect of bounding up natural forces.... The natural rate is a free market idea... Which has nothing to do with the feds attempt to manipulate interest rates.. The market will have the say in the end..
The natural rate of interest is a theoretical concept that has never been viewed as being able to go negative. How surprising that a couple of liberal economists have come up with a new model to validate negative rates right now. It's right on par with their colleagues who've decided that giant deficits and monetizing debt are now good, instead of bad when they weren't in power.
rom Wicksell, whose Interest and Priceswas published in 1898, Mises borrowed the idea that the bank rate of interest sometimes diverges from the "natural" rate of interest, so called by Wicksell. The natural rate, which excludes all monetary influences, was taken by Mises to be the interest rate consistent with consumers' time preferences; the bank rate, which is subject to monetary manipulation, was taken to be the focus of bank policy. Holding the bank rate below the natural rate requires a continuous expansion of bank credit. The divergence of the two rates of interest was of concern to Wicksell primarily because of its effect on the general level of prices. Wicksell acknowledged that bank policy might also affect the allocation of resources, but any such allocational effects were reduced to "tendencies only" by his simplifying assumptions and thus were no part of his formal theory. Mises, in effect, relaxed Wicksell's simplifying assumptions in order to investigate the allocational effects of bank policy. He was specifically concerned with credit expansion in the context of time-consuming, capital-using production processes. Tracing the effects of bank policy on production activity furthered the integration of monetary and value theory and identified the ultimate consequences of a cheap-credit policy. Since the natural rate is the rate of interest that reconciles intertemporal production activities with the time preferences of consumers, credit expansion, by keeping the bank rate below the natural rate, induces a fundamental inconsistency. A cheap-credit policy distorts business calculations causing the production of consumer goods to be reduced and production processes in general to be excessively roundabout. Mises used the term "forced savings" to describe the policy-induced reduction in consumption and the term "malinvestment" to describe the intertemporal misallocation of resources induced by artificially cheap credit. Mises transformed his insights about forced saving and malinvestment into a theory of the business cycle by recognizing the unsustainability of production activities that are based upon a low bank rate. But the idea that the market's responses to credit expansion contain the seeds of their own undoing is older than either the Austrian or the Swedish School. A self-reversing process triggered by bank policy had been identified early in the nineteenth century by members of the Currency School. So similar in form was Mises' theory to the "Circulation Credit Theory of the Trade Cycle," as exposited by Lord Overstone and others, that Mises considered his own theory an extension of the circulation-credit theory rather than a uniquely Austrian theory. However, Mises found the formulation of the Currency School to be inadequate in two respects. First, it gauged bank policy too narrowly in terms of the quantity of banknotes, ignoring the equally if not more significant volume of demand deposits. Secondly, and more importantly, it failed to identify any domestic market forces that might counteract the initial effects of credit expansion. The unsustainability of the boom in the Currency School's formulation derived exclusively from international repercussions. As an expansion of banknotes drove domestic prices upward, exports would fall while imports rose. The trade imbalance would drain gold, the redemption medium, from the expanding banks eventually requiring the banks to contract. It is this specie-flow mechanism, in the Currency School's view, that limits the ability of any one country to maintain a cheap-credit policy. Mises' formulation advanced the circulation-credit theory by showing that credit expansion is unsustainable even in a closed economy—or in an open one in which the banks of all countries expand together. In the early phase of a credit expansion, workers receive income from production activities undertaken on the basis of a low bank rate of interest, but those same individuals, as consumers, spend their income at a rate corresponding to the higher natural rate of interest. This consumer spending eventually counteracts the initial effects of credit expansion. The rise of consumer-good prices, which demonstrates the true strength of consumers' preferences for goods now over goods later,discourages the relatively more roundabout production processes that cheap credit initiallyencouraged. Attempts by the central bank to reinforce the credit expansion will also reinforce the market's "countermovements," as termed by Mises. As market forces continuously counteract bank policy, the artificial boom is eventually brought to an end. Some production processes that were initiated during the period of cheap credit can be completed only at a loss, while others must be liquidated. Even apart from international considerations, the credit expansion contains the seeds of its own undoing. In sum, Mises saw the boom as a consequence of unenlightened bank policy, a period of artificial and unsustainable expansion, in which capital and other resources are committed to excessively roundabout production processes, and he saw the bust as the inevitable consequence of the credit-induced boom. In the end, the pattern of consumer spending wins out over the pattern of bank lending. Mises saw the recovery as the period during which malinvestments are liquidated and production activities are again reconciled with actual consumer preferences. Mises recognized, as did Wicksell, that enlightened bank policy would avoid credit expansion, thus minimizing the divergence between the bank rate and the natural rate. Believing, however, that central bank policy as formulated by government officials would be ideologically biased towards cheap credit, Mises favored institutional reform in the direction of free banking. Mises' theory underwent substantial development by F. A. Hayek, whose Prices and Production influenced many British theorists, and remains a part of the research agenda of the modern Austrian School. But the Austrian theory of the business cycle has not been incorporated into mainstream macroeconomic theory. Several factors have inhibited a broader acceptance of Mises' views. First, mainstream macroeconomics since the Keynesian revolution has developed with no grounding in capital theory of the sort that underlies Austrian business-cycle theory. Thus, a capital-theoretic account of the unsustainability of a credit-induced boom, when grafted onto a macroeconomic theory that is otherwise free of such considerations, appears ad hoc and unduly complex. Second, because of fundamental difficulties in measuring capital and roundaboutness, especially in the context of artificial booms and consequent busts, the empirical—largely episodic—support for the Austrian theory does not conform well to the econometric procedures for model evaluation that have come to characterize modern empirical economics. And third, the implied policy of avoiding artificial booms as the only way of avoiding the otherwise inevitable bust, is unattractive to policy activists committed to the goal of initiating and perpetuating economic booms.