Abstract
AbstractThe “natural rate of interest” is the hypothetical, risk-free real rate of interest that would obtain in a closed economy, if net public debt were zero. It is considerably less than the optimal steady-state rate of interest, which is equal to the system’s growth rate. This holds for a very general “meta-model.” The fundamental equation of capital theory holds on the optimal steady-state path: T = Z − D, where T is the overall economic period of production, Z is the representative private “waiting period” of consumers and D is the public debt ratio. Prosperity is at least 30% lower at the natural rate of interest than at the optimal rate.
Highlights
The “natural rate of interest” is the hypothetical, risk-free real rate of interest that would obtain in a closed economy, if net public debt were zero
Definition For us, the natural rate of interest is the risk-free, real rate of interest that is compatible with full employment in a closed economy without public debt that is growing at a constant rate
In conjunction with the equation that we just derived for r = g, this shows us that the natural rate of interest is smaller than g precisely when, at a rate of interest r = g, the private waiting period is greater than the period of production
Summary
The term “natural rate of interest” goes back to Knut Wicksell (Wicksell [1898]). In his important book Interest and Prices, Wicksell identified the function that a central bank is supposed to fulfill by way of its interest rate policy. For analytical purposes, we are interested in the question of how high the real full employment interest rate would be, if there were no public debt. This is the interest rate that we call the “natural rate.”. Definition For us, the natural rate of interest is the risk-free, real rate of interest that is compatible with full employment in a closed economy without public debt that is growing at a constant rate. The natural rate of interest defined in this way is the reference point from which we consider the current global economic landscape The latter, includes a high level of net public debt.
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