Lifting the Veil on Interest

Abstract

The central bank practice which emerged in the period following the financial crisis called into question numerous elements of interest rate considerations. In this paper we present a new theoretical framework that dispenses with the concept of real interest altogether, as a vague and unnecessary category both in policy judgements and business decisions. This approach breaks with the traditional theory of economics. Traditional macroeconomics places its argumentation in the context of real analysis, which hinders the understanding of economic processes. Schumpeter and subsequently, Keynes took a stand against this approach and, rebuffing the real approach, turned to monetary analysis as early as a century ago. In the framework of the classical theory of economics, they describe monetary policy as an adjustment to the natural rate of interest. In this article we propose a different approach. Describing the role of fiat money, the endogenous money theory puts the lending activity of commercial banks into the focus of money creation. This concept also put central bank monetary policy in a new framework. According to this approach, central banks assume an exclusive role in determining the interest rates, but the central significance of the interest rate policy weakens. Once we recognise the crucial role of commercial banks in money creation, the role and function of the central bank changes. The central bank no longer controls money creation solely by shaping the interest rate policy, but also by way of the micro and macroprudential regulation of lending.