The Natural Rate of Interest (4)

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Continued from here.

Income is boosted by investment, and income makes possible (additional) saving. So what money created from nothing by banks achieves is that additional investment is called into existence which supports more/new income (part of) which can be diverted into saving. So it is not saving that makes investment possible. To the contrary, it is investment made possible by the banks' ability to create money out of nothing that gives rise to additional savings. So, quite unlike the theory of the natural rate of interest claims, there is no naturally/neutrally and necessarily/automatically equilibrating mechanism at work, whereby interest rate changes reduce/increase investment while increasing/reducing saving to keep both always in balance. Instead there is endogenous money creation which is not at all of the automatically equilibrating kind, but quite powerfully capable of supporting productive investment no less than massive misallocations of economic resources.

Postulated by mainstream economics, the idea that money is neutral suggests that it does not affect the real economy.  In reality, money is not neutral, both in the sense 

• (1) that it puts us in the position to make productive investments that we could not have made in its absence, and 

• (2) that it gives us the means to pump up huge bubbles of unproductive investments throwing the economy into crisis.

The natural rate of interest as conceived by mainstream economics does not exist, as the equilibrating mechanism that would be required for it to be determined is a mere figment of the mind — it is absent in the real world where the relationship between saving and investment is characterised by a completely different process.

Writes Bill Mitchell about the theory of the natural interest rate — my emphasis in the below text:

So the interest rate adjusts to the natural interest rate where the full-employment level of savings equals investment and all is well. There is never a shortage of investment projects but their introduction is impacted upon by the cost of funds. There is never unemployment!

Marx by the way had already disassembled all this nonsense in Capital and I urge you to trace out his argument, for to some extent, what followed (Keynes and Kalecki) was anticipated by Marx.

Anyway, it was exactly these issues that Keynes tackled in the General Theory. In Chapter 14, Keynes said (page 189) that:

The classical school proper, that is to say; since it is the attempt to build a bridge on the part of the neo-classical school which has led to the worst muddles of all … This leads on to the idea that there is a “natural” or “neutral” … or “equilibrium” rate of interest, namely, that rate of interest which equates investment to classical savings proper without any addition from “forced savings” … But at this point we are in deep water. “The wild duck has dived down to the bottom — as deep as she can get — and bitten fast hold of the weed and tangle and all the rubbish that is down there, and it would need an extraordinarily clever dog to dive after and fish her up again.”

Thus the traditional analysis is faulty because it has failed to isolate correctly the independent variables of the system. Saving and Investment are the determinates of the system, not the determinants. They are the twin results of the system’s determinants … [aggregate demand] … The traditional analysis has been aware that saving depends on income but it has overlooked the fact that income depends on investment, in such fashion that, when investment changes, income must necessarily change in just that degree which is necessary to make the change in saving equal to the change in investment.

In other words, the orthodox position that the interest rate somehow balances investment and saving and that investment requires a prior pool of saving are both incorrect. We learned categorically that investment brings forth its own saving through income adjustments.

What drives all this is effective demand – spending backed by cash (Marx definitely wrote about that in Theories of Surplus Value). The 1930s totally discredited the Wicksellian ideas about the dynamics of the economy and the centrality of interest rate adjustments in stabilising the economy.

But that failed paradigm reappeared in the 1970s and by the 1990s was dominant again. All this talk about neutral interest rates really inherits all that baggage.