Real and Monetary Theories of the Interest Rate

Abstract

The origin of most mainstream theories about interest rates goes back to Irving Fisher. Fisher’s concept of the equilibrium real rate of interest and the related Wicksellian concepts of “natural” or “neutral” rate are assumed to be essential for inflation-targeting frameworks. It is believed that this assumption explains the widely and confidently held conviction that monetary policy should focus on inflation expectations to keep real interest rates at a stable level to promote savings and investment. We argue that there are several problems with this approach, which relies on the principles of “real analysis” as opposed to the “monetary approach” reflected in the works of Schumpeter and Keynes. Post-Keynesian monetary theory offers a framework corroborated by central bank practices. We use some examples from the experience of the Magyar Nemzeti Bank (the central bank of Hungary) following the global financial crisis that may provide some hints for refocusing contemporary monetary policy and related theories.

Keywords:

•  modern monetary theory
• interest rate
• monetary policy
• post-Keynesian analysis

NOTES

Notes

1 Tymoigne (2006: 2), italics added for emphasis.

2 “The rate of interest ‘is not the result of a market equilibrium; it necessarily arises as an act of economic policy’ (Creel and Sterdyniak 1999: 528)” – quoted by Lavoie (2004: 20)

3 There remained important differences between the New Consensus and MMT in these two aspects. Endogeneity of money supply in the New Consensus approach means that the amount of money is determined by the banking system through the money multiplication of central bank reserves (inside money), while in MMT it is credit money created by the commercial banks. But there is also endogenous central bank (or outside) money emerging to fulfill public finances’ needs of governments. Similarly, the central bank determines the interest rate, which is exogenous, but according to the New Consensus models, it gravitates towards a long-term natural rate, which is a real equilibrium rate. In MMT, there is no such mechanism assumed and even the notion of real rate is largely put aside.

4 The mainstream new consensus still relies on the principles of real analysis as opposed to the monetary approach reflected in the works of Schumpeter (1911/1934) and Keynes (1936).

Additional information

Notes on contributors

Istvan Abel

Istvan Abel is Full Professor, Faculty of Finance and Accounting, Budapest Business School, Budapest Economic University (BGE), Budapest, Hungary and Kristof Lehmann is Associate Professor, Head of MNB Department, Budapest Corvinus University, Budapest, Hungary, and Director, Directorate for International Monetary Policy Analysis and Training of Economic Sciences, Magyar Nemzeti Bank (MNB), Budapest, Hungary. He can be contacted at [email protected]. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of the Magyar Nemzeti Bank (Central Bank of Hungary).

Kristof Lehmann

Istvan Abel is Full Professor, Faculty of Finance and Accounting, Budapest Business School, Budapest Economic University (BGE), Budapest, Hungary and Kristof Lehmann is Associate Professor, Head of MNB Department, Budapest Corvinus University, Budapest, Hungary, and Director, Directorate for International Monetary Policy Analysis and Training of Economic Sciences, Magyar Nemzeti Bank (MNB), Budapest, Hungary. He can be contacted at [email protected]. The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of the Magyar Nemzeti Bank (Central Bank of Hungary).