Department of "Huh?!": William White Misinterprets Wicksell Department
William White writes:
Ultra Easy Monetary Policy and the Law of Unintended Consequences: Perhaps a good jumping off point for such analyses might be the pioneering work of Knut Wicksel[l]. He made the distinction between the “natural” rate of interest, which equalized ex ante saving and investment plans, and the “financial” rate of interest, set by the banking sector. Differences between the two were thought by him to lead to undesired price movements and/or to economic “imbalances”, the importance of which would depend on the size and duration of the differences between the two rates.
Were we to adopt this analytical framework, policymakers today would seem to have serious cause for concern. The “natural rate” of interest (real) for the global economy as a whole can be proxied by the potential rate of growth of the global economy, as estimated by the IMF. Reflecting globalization and technology transfer, this measure has been rising steadily for the last twenty years. In contrast, if one proxies the financial rate of interest (real) by an average of available breakeven rates (say for ten year TIPS), this measure has been falling for the last twenty years. Moreover, at the global level, the natural rate of interest rose above the financial rate in 1997, and the gap has essentially been widening ever since52. From this perspective, underlying inflationary pressures and/or “imbalances” have already been cumulating for many years. Since recent ultra easy monetary policy initiatives are effectively “still more of the same”, there would then seem to be a prima facie case for raising concerns about the unintended consequences of monetary easing…
But… but… but…
I do adopt the Wicksellian framework on occasion.
There is no counterfactual "were we" about it.
I understand it.
In the Wicksellian framework, the natural rate of interest is the interest rate at which planned investment (plus net borrowing from the government) is equal to desired saving at full employment (plus the net capital inflow from abroad). If the market rate of interest is below the natural rate, planned investment is greater than desired savings, businesses seeking to invest cannot sell enough bonds to finance investment and thus dip into their cash reserves, the monetary hot potato starts, and you get unexpected and rising inflation (and full or over-full employment).
William White says that the natural rate of interest is above the market rate. But he is wrong: we don't see businesses dipping into their cash reserves to find investment, a monetary hot potato, unexpected and rising inflation, and full or over-full employment.
Instead, we see elevated unemployment and firms and households adding to their cash reserves. This is what Wicksell expected to see when the natural rate of interest was below the market rate: planned investment would then be lower than desired savings, households and businesses seeking to save would be unable to find enough bonds to balance their portfolios, they would then transfer some of their cash out of transactions balances and treat them as unspendable savings (the "precautionary" or "speculative" demand for money), we would see too little money to buy all the goods and services that would be put on sale at full employment, and we would see no signs of inflation but a depressed economy.
That is the root of our problem: the natural nominal rate of interest--the rate of interest that balances planned investment (plus etc.) and desired savings (at full employment, plus etc.)--today is less than zero, and so the Federal Reserve cannot push the market nominal rate of interest down low enough. The alternative solutions are (i) DeLong-Summers expansionary fiscal policy which raises the natural rate of interest up to the market rate and rebalances the economy so it can attain full employment; and (ii) Woodford-Krugman-Eggertsson raise-inflationary-expectations policy that raises the nominal rate of interest up to the market rate and rebalances the economy so that it can attain full employment.
I really do not know what White is talking about here. Whatever it is, it is not the model underpinning Wicksell's Geldzins ind Guterpreis.
