Krugman offers a full argument with graph, which you should read in total, but here is one bottom line summary:
When I say that the rate is too high, I mean relative to the rate that would produce full employment, which is, as Brad reminds us, Wicksell’s “natural rate”.
And here is his opening bit:
One of the baffling aspects of economic debate during this Lesser Depression, or so it seems to me, is the apparent urge of many economists to shy away from straightforward conclusions, the urge to make the simple complicated and the clear blurry.
If you’re asking what is at stake, it is whether we should be confident or even mildly confident about any predictions made through a liquidity trap model. I’ll stick with a few points, which I will put under the fold…
1. I am persuaded by Scott Sumner that, at least these days, the interest rate channel is not very important. Given that, one still can favor looser money, or at the very least think that tighter money would make things worse, even if the gains from looser money have by 2013 mostly come to an end.
2. I am struck by the remarks of Angus that:
Again and again I see the economy’s problem described along these lines:
“At the ZLB (zero lower bound), the real interest rate is too high to get us to the optimum. The nominal interest rate cannot fall any further by definition. So to get to the optimum the expected rate of inflation must rise.” Those are Simon Wren-Lewis’ words (they appear in a comment at the link), but Krugman and many others tell roughly the same story.
As always, I have questions.
In the IS/LM framework many (not Wren-Lewis) are using, doesn’t this mean that we are getting “growth” by firms investing in projects with a negative NPV now made profitable by an even more negative discount rate?
Second, how is that inflation expectations rise and the nominal interest rate remains unchanged?
Brad’s rather abstract talk about “lower” interest rates does not deflect me from recognizing this visceral wisdom from Cherokee Gothic. I am sorry, but on this one I have to vote for “complicated,” not “simple.” I will gladly admit that I do not myself have the final answers here.
3. It is not always useful to talk of “*the* interest rate” and apply that across both Treasury securities and the private sector. Our government can borrow at some negative real rates, but are we really to think that the private sector is looking at negative rates of return in the United States? Hardly. Wicksell, yes, but in this case we need some Sraffa too. Some kind of asset segmentation is going on, as David Beckworth and others have stressed, and that segmentation does matter a great deal for the transmission belt of monetary policy, at least to the extent you believe in an interest rate mechanism.
4. This is a side point, but it is Brad who doesn’t get Wicksell and Wicksell’s theory of the natural rate of interest. Brad blogged:
The large demand for relatively safe assets like U.S. Treasury securities means that the interest rate consistent with full employment–the “natural” interest rate, in Wicksell’s terms–is lower than normal, and the natural rate is in fact less than zero.
On the natural rate of interest, what did Wicksell actually write?:
There is a certain rate of interest on loans which is neutral in respect to commodity prices, and tend neither to raise nor to lower them. This is necessarily the same as the rate of interest which would be determined by supply and demand if no use were made of money and all lending were effected in the form of real capital goods. It comes to much the same thing to describe it as the current value of the natural rate of interest on capital.
That’s from the beginning of chapter eight. Now it’s more complicated than that, as Wicksell juggles and sometimes equates three or four different definitions of the natural rate of interest, not to mention the contrast between the natural rate of interest and the normal rate of interest. David Laidler once referred to the “Wicksellian muddle.” Still, DeLong is barking up a different tree.
Brad also chides me for neglecting “basic Geldzins und Guterpreis”, but speaking of basics he neglects the umlaut and also the plural on “price”, so it should be “Güterpreise“, the German-language title then being translated somewhat inexactly into “Interest and Prices.”
5. Stephen Williamson has some interesting comments on the issue. John Cochrane has an excellent post on this entire question, and it will not push you into thinking the matter is simple. I also recommend these Scott Sumner remarks.
You will recall Cowen’s Third Law: “All propositions about real interest rates are wrong.”