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The Zero Lower Bound and the Asymmetric Efficacy of Monetary Policy: A View from the History of Economic Ideas

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Abstract

The monetary authorities of advanced economies have used the Wicksellian distinction between the natural rate of interest, also called the equilibrium real rate of interest, and the rate of interest on money to explain the partial ineffectiveness of the measures taken to deal with the Great Recession. They have explained that the instrument of the rate of interest on money produces asymmetric effects. Indeed, to fight high inflation central banks can increase the level of the rate of interest on money without limits. However, if they had to fight deflation they could not lower the rate of interest on money below zero. The presence of a negative value of the natural rate of interest has been indicated by the monetary authorities to justify the limited effectiveness of monetary policy during the Great Recession. The aim of this work is to show that the Wicksellian concept of natural rate of interest cannot be used to explain the functioning of contemporary economies. The limits of this concept will be specified by using the arguments developed by Keynes and Schumpeter to emphasize the exclusively monetary nature of the rate of interest.

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Notes

  1. “However much ‘money’ is demanded in the banks, they can pay it out without danger of insolvency, since they do nothing about it, but enter a few figures in their books to represent a loan granted or a deposit withdrawn; the cheques and orders drawn against these must necessarily come back into the banks within a few days, and are credited to the depositors as a deposit paid in or a debt paid off. Supply and demand of money have in short now become one and the same thing.” (Wicksell 1898, p. 76)

  2. Wicksell defines the natural rate of interest by considering “the phenomena of capital and interest on capital, as they would appear if liquid capital, production’s means of support, was in reality lent in kind, without the intervention of money; and only then is it possible to distinguish what modifications are in reality caused by the introduction of money. In the former case, i.e. if capital was lent in kind, there would undoubtedly develop, through the supply of and the demand for available capital, a certain rate of interest on the lending market, which would be the natural rate of interest on capital in the strictest sense.” (Wicksell 1898, p. 84)

  3. As remembered by Goodspeed, Wicksell claims that: “it is […] confidently to be expected that the Bank rate, or more generally the money rate of interest, will always coincide eventually with the natural capital rate, or rather that it is always tending to coincide with an ever-changing natural rate.” (Goodspeed 2012, p. 23)

  4. See also Draghi (2016a, b, c), Bernanke (2015), Kiley (2015) and Fischer (2016).

  5. As underlined by the President of the ECB Draghi: “[…] while our mandate is symmetric, and our commitment to our mandate is symmetric, there is an asymmetry in the tools we can use to achieve it, which stems from the existence of a lower bound for interest rates. When inflation is too high, we can always raise interest rates to a level that will rein in demand and eventually prices. And as this is widely understood from historical experience, our credibility relies only on one parameter: our willingness to fight excessive inflation. Our ability to do so is taken for granted. When inflation is too low, however, there are limits to how far interest rates can be cut, because of the existence of a non-interest bearing substitute for bank deposits in the form of cash.” (Draghi 2016b, p. 3)

  6. Since mainstream economists recognize that the natural rate of interest is not observable, they developed some methodologies to estimate its value. According to many studies, during the period 2009–2015 the natural rate of interest has reached even negative values. For example, see Laubach and Williams (2003), Barsky et al. (2014), Curdia et al. (2014), Curdia (2015), Goldby et al. (2015), Pescatori and Turunen (2015), Holston et al. (2016) and Constâncio (2016).

  7. Several economists have emphasized the desirability of integrating the Keynesian theory of income determination with Schumpeter’s theory of economic development. For example, see Minsky (1986, 1993), Morishima (1992), Goodwin (1993), Vercelli (1997), Bertocco (2007), Dosi (2012), Dosi et al. (2010) and Mazzucato and Wray (2015).

  8. “An economy, which uses money but uses it merely as a neutral link between transactions in real things and real assets and does not allow it to enter into motives or decisions, might be called—for want of a better name—a real-exchange economy. The theory which I desiderate would deal, in contradistinction to this, with an economy in which money plays a part of its own and affects motives and decisions and is, in short, one of the operative factors in the situation, so that the course of events cannot be predicted, either in the long period or in the short, without a knowledge of the behaviour of money between the first state and the last. And it is this which we ought to mean when we speak of a monetary economy”. (Keynes 1933a, pp. 408–409)

  9. “The roots of [the natural rate of interest] reach very far into the past […]. Its role in the thought of our own time is due to the teaching of Knut Wicksell and the work of a brilliant group of Swedish and Austrian economists. For us, however, there is no such thing as a real rate of interest, except in the same sense in which we speak of real wages: translating both the interest and the capital items of any loan into real terms by means of the expected variation in an index of prices. […] But nominal and real rates in this sense are only different measurements of the same thing […]. Hence, the money market with all that happens in it acquires for us a much deeper significance than can be attributed to it from the standpoint just glanced at. It becomes the heart, although it never becomes the brain, of the capitalist organism.” (Schumpeter 1939, pp. 101–102)

  10. “Monetary analysis introduces the elements of money on the very ground floor of our analytical structure and abandons the idea that all essential features of economic life can be represented by a barter-economy model. Money prices, money incomes, and saving and investment decisions bearing upon these money incomes, no longer appear as expressions […] of quantities of commodities and services and of exchange ratios between them: they acquire a life and an importance of their own, and it has to be recognized that essential features of the capitalist process may depend upon the ‘veil’ and that the ‘face behind it’ is incomplete without it.” (Schumpeter 1954, p. 278)

  11. In Schumpeter’s view the mechanism of bank money creation: “alters the analytic situation profoundly and makes it highly inadvisable to construe bank credit on the model of ‘existing funds’ being withdrawn from previous uses by an entirely imaginary act of saving and then lent out by their owners. It is much more realistic to say that the banks ‘create credit’, that is, that they create deposits in their act of lending, than to say that they lend the deposits that have been entrusted to them. And the reason for insisting on this is that depositors should not be invested with the insignia of a role which they do not play. The theory to which economists clung so tenaciously makes them out to be savers when they neither save nor intend to do so; it attributes to them an influence on the ‘supply of credit’ which they do not have. The theory of ‘credit creation’ not only recognizes patent facts without obscuring them by artificial constructions; it also brings out the peculiar mechanism of saving and investment that is characteristic of full-fledged capitalist society and the true role of banks in capitalist evolution.” (Schumpeter 1954 [1994], p. 1114)

  12. Similar arguments are expressed, for example, by Fontana (2006), Skidelsky (2009, 2011) and Asensio (2013–14).

  13. “The attitude of business […] is a case of M–C–M′, i.e. of parting with money for commodity (or effort) in order to obtain more money. This is important for the following reason. The classical theory supposes that the readiness of the entrepreneur to start up a productive process depends on the amount of value in terms of product which he expects to fall to his share; i.e. that only an expectation of more product for himself will induce him to offer more employment. But in an entrepreneur economy this is a wrong analysis of the nature of business calculation. An entrepreneur is interested, not in the amount of product, but in the amount of money which will fall to his share. He will increase his output if by so doing he expects to increase his money profit, even though this profit represents a smaller quantity of product than before.” (Keynes 1933b, pp. 81–82)

  14. “Our knowledge of the factors which will govern the yield of an investment some years hence is usually very slight and often negligible. If we speak frankly, we have to admit that our basis of knowledge for estimating the yield 10 years hence of a railway, a copper mine, a textile factory, the goodwill of a patent medicine, an Atlantic liner, a building in the City of London, amounts to little and sometimes to nothing; or even 5 years hence.” (Keynes 1936, pp. 149–150)

  15. Paul Davidson (2007) uses the concept of ‘crucial decisions’ to emphasize the link between Keynes and Schumpeter. In particular, he introduces the distinction between ergodic and non-ergodic systems: “If entrepreneurs have any important function in the real world, it is to make crucial decisions. Entrepreneurship […] involves cruciality. To restrict entrepreneurship to robot decision making through ergodic calculations in an ergodic stochastic world […] ignores the role of the Schumpeterian entrepreneur—the creator of technological revolutions that bring about future changes that are often inconceivable even to the innovative entrepreneur.” (Davidson 2007, p. 112)

  16. “[the natural rate of interest] is merely the rate of interest which will preserve the status quo; and, in general, we have no predominant interest in the status quo as such. If there is any such rate of interest, which is unique and significant, it must be the rate which we might term the neutral rate of interest, namely, the natural rate in the above sense which is consistent with full employment, given the other parameters of the system; though this rate might be better described, perhaps, as the optimum rate.” (Keynes 1936, p. 243)

  17. Also Keynes emphasizes that during a crisis a policy of low interest rates is insufficient to reach a full employment situation: “[…] a decline in the rate of interest will be a great aid to recovery and, probably, a necessary condition of it. But […] the collapse in the marginal efficiency of capital may be so complete that no practicable reduction in the rate of interest will be enough. […] it is not so easy to revive the marginal efficiency of capital, determined, as it is, by the uncontrollable and disobedient psychology of the business world.” (Keynes 1936, p. 316)

  18. After criticizing the concept of ‘forced savings’, in the General Theory Keynes describes the relationship between bank money, investment and saving decisions in the following way: “The notion that the creation of credit by the banking system allows investment to take place to which ‘no genuine saving’ corresponds can only be the result of isolating one of the consequence of the increased bank-credit to the exclusion of the others. If the grant of a bank credit to an entrepreneur additional to the credits already existing allows him to make an addition to current investment which would not have occurred otherwise, incomes will necessarily be increased. […] Moreover, except in conditions of full employment, there will be an increase of real income as well as of money–income. The public will exercise a ‘free choice’ as to the proportion in which they divide their increase of income between saving and spending. […] Moreover, the savings which result from this decision are just as genuine as any other savings. No one can be compelled to own the additional money corresponding to the new bank-credit, unless he deliberately prefers to hold money rather than some other form of wealth.” (Keynes 1936, pp. 82–83)

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Bertocco, G., Kalajzić, A. The Zero Lower Bound and the Asymmetric Efficacy of Monetary Policy: A View from the History of Economic Ideas. Ital Econ J 4, 549–566 (2018). https://doi.org/10.1007/s40797-018-0073-7

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