Wednesday, September 23, 2015

Notes on Wicksellian Considerations

At the heart of the Neo-Fisherian dilemma, one also senses a determination to find out if the natural interest rate can be made to "conform" to those who want better returns on their investments! Indeed - as Bonnie Carr recently pointed out - is Janet Yellen even taking the Wicksellian equilibrium into consideration? And after a particularly frustrating CNBC interview with James Bullard, Lars Christensen responds, "Jim, it is not complicated. NGDP tells you NOT to hike."

How much does the Wicksellian natural interest rate matter? In other words, what does today's low level suggest, regarding the current post recessionary equilibrium? Like other observers, I continue to sort through the "fallout" of these discussions. From the Wikipedia page for anyone who might benefit from a "refresher", re Knut Wicksell:
Wicksell died in 1926 while writing a final work on the theory of interest. Elements of his public policy were taken strongly to heart by the Swedish government, including his price level targeting rule during the 1930s...Michael Woodford has especially praised Wicksell's advocacy of using the interest rate to maintain price stability, noting that this was a remarkable insight when most monetary policy was based on the gold standard...Wicksell invented the key term natural rate of interest and defined it as that interest rate which is compatible with a stable price level...If the interest rate falls short of the natural rate, inflation is likely to arise; if the interest rate exceeds the natural rate, this will tend to produce deflation.
Will the Fed induce deflation in the near future, by insisting on prematurely raising interest rates? After all, the so called "strong" economy remains dependent on an incomplete equilibrium, i.e. built on lower labor force participation than what existed prior to the Great Recession. Ultimately, inadequate employment results in problems for both aggregate supply and aggregate demand. As James Alexander recently noted, "The stance of monetary policy can only be measured by looking at whether demand for money is outstripping supply of money, and that can only be seen by looking at where nominal growth (aka Aggregate Demand) is headed." And yet the ongoing requests for central banks to follow aggregate spending capacity, continue to be ignored.

Once labor force participation began to decline, governments "compensated" by utilizing housing stock as means to "park" income for needed capital flows. While this was a reasonable temporary response, production and investment needs to be increased for all income levels. Further, traditional housing construction has been suppressed, well below actual marketplace demand. Decentralized investment strategies are now needed for new housing options, given the fact that centralized (and government) investments are more closely aligned with upper income levels.

Mass production of building components for lower income levels, would be among the most reasonable means to grow the economy on terms which matter for all consumers. It's unfortunate that policy makers haven't seen fit to encourage this development, given the fact more supply and demand for housing would eventually increase the Wicksellian rate of interest on normal terms. Indeed, real innovation which expands the marketplace is precisely what would build the strong economy, which the Fed wants to believe exists, now. Don't raise rates "just because". Raise rates when the work of making a stronger real economy has actually taken place.

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