Transcript Fair Rates of Interest in Post

FAIR RATES OF
INTEREST
IN POST-KEYNESIAN
POLITICAL
ECONOMY
Fair Rates of Interest
In Post-Keynesian Political Economy
Fair rates versus natural rates
 Discussing fair rates usually makes no
sense because most economists
believe in the relevance of the natural
rate of interest
The natural rate of interest
 The natural rate of interest plays a
role similar to that of the natural rate
of unemployment.
 When Milton Friedman presents the
natural rate of unemployment in his
1968 AEA address, he makes the
analogy.
Friedman and the natural rate
 “Thanks to Wicksell we are
acquainted with the concept of the
natural rate of interest….The
preceding analysis [NAIRU] can be
translated fairly directly into
Wicksellian terms. The monetary
authorities can make the market rate
less than the natural rate only by
inflation.”
The natural rate of interest
 The natural rate of interest is said to
depend upon the forces of
productivity and thrift.
 It is the rate of interest that would
exist if the demand for and the supply
of savings could be expressed in real
terms (a loanable funds theory, based
on real capital)
 (See in particular Robertson)
The natural rate of interest in
growth theory -- Solow models
 In Solow’s model, the rate of interest
is an endogenous variable, which
depends on the rate of growth of
population, the propensity to save,
and technology.
 This rate of interest is identical to the
rate of profit. This endogenous rate of
interest is subject to the Cambridge
capital critique.
The rate of interest in “New”
growth theory
 In the so-called new growth theory,
the rate of interest is determined by
technology alone. This rate of
interest, with a given propensity to
save, yields the endogenous rate of
growth.
 The rate of interest so determined is
also subject to the Cambridge capital
controversies.
The necessity of the natural
rate of interest
 The market rate of interest cannot be
any different from the natural rate of
interest. If it were lower than the
natural rate, this would induce
accelerating inflation. Therefore
central banks have no choice in
setting short-term nominal rates of
interest.
Long-term vs short-term rates
 Long term rates (on bonds) reflect the
forces of productivity and thrift (those of
supply and demand). Fluctuations of
long-term rates are a good
approximation of the fluctuations of the
natural rate of interest.
 Short-term rates, as influenced by the
actions of the central bank, must thus
be made to follow the views of the
Market.
Causality
 The mainstream view: long-term
rates cause short-term rates (the
natural rate causes market rates)
 The non-orthodox view: short-term
rates, as set by the central bank,
eventually modify the views of the
Market as to what is the right
convention, through arbitrage (there
is no natural rate)
The post-Keynesian view
 “In the absence of a natural rate of
interest, it can be argued that the
central bank control over short real
rates will ultimately influence the
entire structure of interest rates in
the economy, including long
rates”.(Smithin 1996).
Short rates vs long rates (bis)
 “…Liquidity preference may well
periodically insert a wedge between
those rates of interest which are more
or less directly under the central bank
control and rates elsewhere”.
(Smithin 1996).
Various rates of return
 Rates of interest
 Rates of return on financial assets
(dividend or coupon plus capital
gain)
 Normal rate of profit (the target rate
of return)
 Realized rate of profit (which depends
on the rate of capacity utilization)
 The fair rate of interest
The normal rate of profit
 It depends, according to Sraffians, on
the trend rate of interest (the interest
rate regime) plus a normal
entrepreneurial premium.
 The normal rate of profit is thus the
fair rate of return on real assets, for
a given interest rate regime.
The fair rate of interest -History
 In Antiquity and in the Middle Ages,
the fair rate of interest was
considered to be equal to zero.
The fair rate of interest-Pasinetti (1)
 “The fair rate of interest stems from
the principle that all individual, when
they engage in debt/credit relations,
should obtain, at any time, an
amount of purchasing power that is
constant in terms of labour” (Pasinetti
1981).
The fair rate of interest Pasinetti (2)
 “The [fair] rate of interest is that rate
of interest which realizes through
time a distribution of income among
the participants to the production
process, which is proportional to the
physical quantities of labour they
have contributed” (Pasinetti 1993).
The fair rate of interest (3)
 The fair rate of interest maintains the
purchasing power, in terms of
command over labour hours, of funds
that are borrowed or lent.
 It preserves the intertemporal
distribution of income between
borrowers and lenders.
The fair rate of interest practical definition (1)
 The fair rate of interest in real terms
should be equal to the rate of
increase in the productivity of the
total amount of labour that is
required, directly or indirectly, to
produce consumption goods and to
increase productive capacity
The fair rate of interest practical definition (2)
 Should equal the correctly measured
multifactor productivity growth rate.
 In the special case where the profit
rate is constant through time, it
should exactly equal the growth rate
of real wages.
Fair rates, the Church and the
Coran
 In Antiquity, and in the Middle Ages,
although economies experienced
some swings in activity, it may well
be that observers felt that they were
in some sort of a stationary state.
 With no inflation and no technical
progress, the fair nominal rate of
interest was zero.
Simple example
Wage at the start of the year is $10.00/hour.
There is a $10,000 loan
This is like 1000 hours of labour time.
Real wages grow by 2%. Inflation is 5%.
Nominal wages at the end of the year: $10.70
If the rate of interest charged is 7%, then the
borrower will have to reimburse $10,700.
 This is also equivalent to 1000 hours of labor.
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What should real rates of
interest be now?
 Smithin (1996) argues that central
banks should target after-tax real
rates of interest at positive levels of
1% or 2% (before tax levels of 2 to 3
per cent ?)
 Over the last ten years, in Canada,
multi-factor productivity growth has
been 0.6% a year. This is what real
rates ought to be for rates to be fair.