Saturday, July 6, 2013

Natural Rate of Interest Does it Exist?

What is the natural rate of interest, it should be an obvious answer to any reader in economics. There is much debate about what is the natural rate of interest, what is it? Before we answer this question, we must ask ourselves what is the core of economic theory. The core of economic theory is about supply and demand. In EC 101 one learns that prices tend to move towards where demand and supply are equal. Then it is shown what happens when you have subsidies, taxes, tariffs, all government action to either shift the supply function or the demand function. Prices tend to move so that demand and supply equate.

What then is the natural rate of interest. The natural rate of interest has nothing to do with anything, it is when the price of money is set by demand for money and supply of money. The market sets the natural rate of interest. The market is the whim of the economic participants, you and I, and everybody else demanding and supplying money.

The natural rate of interest is therefore the market rate of interest and it changes every so often according to new information and increase in money that is willing to be lent, or decrease in borrower’s appetite to borrow more money. But the question must be asked, is there a natural rate of interest.

Yes there is a natural rate of interest, but that natural rate can rarely exist where there is fiat money, that is the unfortunate truth. Fifteen people, men or women deciding what the interest rate should be is certainly not a market process, the market is the citizenry the millions of individual choices, not fifteen people who have decided they are smarter than everybody else not be deeds but by appointment. A doctorate in a false theory is still junk no matter how it is presented to the naive and ignorant.

Writing pages and volumes on how best to print money is meaningless even if you win the highest awards, as long as a board of people control the money supply, the tool for exchange of goods and services, a false sense of achievement is created, because money is essentially just a tool for exchange, never the good or service, money is not a pen, or is it a fridge.

What we see today is not the natural rate of interest, one can not even call it the market rate in its true sense, it would be better known as the bureaucratic/ regime rate of interest, as it is set by bureaucrats.

Taking out control of money supply from government hands and we will get a pure market rate not a bureaucratic rate of interest, that market rate will be the natural rate of interest. It will always be changing, just like the universe is ever changing.

Bhekuzulu Khumalo


Christa said...


Russell said...

I agree completely with your argument but I just one to add one thing. When you said that "money is essentially just a tool for exchange" - I would add that money is also a store of value, and unit of account. Keynsians emphasize money as a medium of exchange which is their justification for control of interest rates. The lower the rate the more transactions take place. Austrians emphasize money as a store of value - if rates float to their natural level and no money printing takes place money maintains its purchasing power.

Mike said...

Money is a sign in our society of success. That is I think what motivates people to have a huge amount even if after a while it's meaningless.



Blog Archive

Bhekuzulu Khumalo

I write about knowledge economics, information, liberty, and freedom