Sankowski uses Roger Ferguson of the Fed's definition:
One way of providing that benchmark is to consider what level of the real federal funds rate, if allowed to prevail for several years, would place economic activity at its potential and keep inflation low and stableHe then adds some variations on that theme, including:
If it were in our power to regulate completely the price system of the future, the ideal position . . . would undoubtedly be one in which, without interfering with the inevitable variations in the relative prices of commodities, the general average level of money prices . . . would be perfectly invariable and stable.Note that implicit in all of this is the idea that somehow there is a tight causal coupling between the Federal Funds rate and inflation, and if the experience of the US since 2008, or Japan since 1990 have taught us anything, it's that this is not so. And without this tight, causal coupling, having a "natural rate of interest" flow from a non-inflationary, high economic activity state becomes problematic.
An alternative view on the "natural rate of interest" is from Warren Mosler, who perhaps inspired Sankowski posing the question at all. Mosler argues that the natural rate of interest is zero, at least under a floating rate, fiat regime. His argument is that, absent active management from the Fed, the overnight interbank interest rate would be zero because having a surplus of reserves drives the rate down to zero (as we see in our current excess reserve regime). Moreover, having a deficit of reserves risks breaking the payment settlement system itself, which would be catastrophic.
Having the FFR be permanently set at zero is a strange idea to wrap your head around, but it's also where we've been for five years and where Japan has been for a generation. It's been hard for the Fed to taper off this state, so maybe it would be for the best if they declared it permanent and left future economic stimulus firmly in the realm of fiscal interventions.
The natural or free market rate of interest is the one that would prevail given no government or central bank interference in the market. And given that governments borrow ASTRONOMIC sums, it’s pretty obvious that “interference” takes place.
ReplyDeleteBut that point raises more questions than it answers. For example, government borrowing so as to cover current as opposed to capital spending is presumably not justified: i.e. that’s an “interference”. And as to borrowing to cover capital spending, it’s widely accepted that that’s justified. However Kersten Kellerman challenged that idea here:
http://www.finess-web.eu/fileadmin/user_upload/euroframe/docs/2004/session2/eurof04_kellermann.pdf
And then Warren Mosler and Milton Friedman argued that governments shouldn’t borrow anything. Like I say, it’s a complicated issue.