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posted on 14 May 2016

The Unnatural Rate Of Interest

Written by , Steve Keen's Debtwatch

Editor's note: When Prof. Keen posted this article 28 October 2015 at Forbes, he suggested that the topic was "wonkish". It may be that some of the arcane details are wonkish, but the essential point is definitely far from wonkish (studying a subject or issue in an excessively assiduous and thorough manner): There is no self-consistent defintion of any single "natural rate of interest". See Tyler Cowen for a summary of the logical problems involved with the concept. Now read Keen's take on the subject coming from a direction almost completely different from the Cowen discussion. Steve finds the logical defects of a natural rate of interest remind him of another quite unrelated economic theory, Marx's labor theory of value.


Paul Krugman's column published several months ago - "Check Out Our Low, Low (Natural) Rates" (which he didn't flag as "Wonkish", even though it is so in spades) - noted that the "natural real rate of interest" was falling, and that this justified the low interest rate set by the Federal Reserve.

And this made me think about Karl Marx.

Why? Because the "natural real rate of interest" is an unobservable entity - in that it's not a rate you'll find charged by any bank, but a rate that has to be statistically derived. But more importantly, it is a fantasy: there is no such thing. However it is required as part of a theory in which the economy returns to equilibrium after it is hit by an "exogenous shock". So Neoclassical economists - meaning both "New Classicals" and "New Keynesians", as the two fractious clans in this economic tribe call themselves - have to go in search of this phantom.

Marx had an equally important unobservable fantasy at the heart of his attempt to produce a mathematical version of his own economics: the "Labor Theory of Value". This is the proposition that all value - and hence all profit - emanates solely from labor. Machinery, Marx asserted, simply passed on the value that had been transferred to it by the labor expended in making it.

It is mathematically impossible to reconcile this proposition with the Marxist belief that profit rates in different industries converge (for competitive reasons), when you acknowledge that different industries have different ratios of capital to labor. But Marxist economists have tied themselves up in logical (and illogical) knots over this fantasy for well over a century.

However Marxists have something over Neoclassicals in this regard: at least they're aware that there is an issue. Even though they continue to cling to this belief, they don't shy away from acknowledging the conundrum. Neoclassicals, on the other hand, don't even realize that they might have a problem.

Some Marxists attempted to circumvent their conundrum on statistical grounds, while making the dubious assumption that the actual wage corresponded to an important concept in Marxian economics, the "value of labor power" (which strictly speaking is a subsistence wage). The great British scholar Ronald Meek rightly derided this fudge, stating that he was "unconvinced by ... redefining `the value of labour-power' so that it becomes equivalent ... to any wage which the workers happen to be getting" (Meek 1956).

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