Brad DeLong's Semi-Daily Journal: A Weblog

Neo-Wicksellian Economics from Roger Ferguson

Fed Vice-Chair Roger Ferguson gives a speech about what pre-Keynesian business-cycle theorist Knut Wicksell called the "natural rate of interest." This adds another data point to the idea that this concept is the, or one of the, ways the current Federal Reserve thinks about monetary policy.

This poses me a problem. I'm revising my macroeconomic textbook right now. If this is how the Fed (or a substantial chunk of the Fed) thinks about monetary policy these days, I need to teach it. But where? Somewhere in chapter 12 on inflation and unemployment in the sticky-price business-cycle model, I think:

FRB Speech: Ferguson--Equilibrium Real Interest Rate: Theory and Application--October 29, 2004: What is needed is a benchmark summarizing the economic circumstances--including, among other variables, the underlying strength of aggregate demand, the level of aggregate wealth, and economic developments in our trading partners--combining to shape the expansion of activity and the extent of pressures on inflation. 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 stable. If the actual real rate is below that benchmark level, policy can be viewed as accommodative, in that if that stance were maintained, ultimately pressures on resources would build. If the actual real rate is kept above that benchmark level, policy would seem to be contractionary. This definition makes clear that the most relevant aid in policymaking is an intermediate-run measure, in that there may be forces at work in the shorter run that push spending away from potential output even if the real rate were pegged at this benchmark rate. It also makes clear that the concept involves a good amount of judgment--indeed, the same judgment that goes into making any economic forecast--about the determinants of spending, the trend of productivity, and the forces affecting inflation in the intermediate term.

Economists famously cannot agree on much. In this case, we cannot even agree on the name of the benchmark concept that I have just described. The real interest rate consistent with the eventual full utilization of resources has been called the equilibrium real federal funds rate, the natural rate of interest, and the neutral real rate. I prefer the first name, the equilibrium real federal funds rate, because, by using the word "equilibrium," it reminds us that it is a concept related to the clearing of markets. Even if economists settled on a name, however, we are not likely to agree on a single model to describe a system as richly complicated as the U.S. economy. Thus, there are as many ways of estimating the equilibrium real federal funds rate as there are different economic models.