Brad DeLong's Semi-Daily Journal (2004)

At 106 years that should be 'the triumph of the great-grand sons and daughters of Knut'.

It's nice to see one's ideas live. But there is that pesky problem of actually defining the natural rate outside the steady state. I'm sure the Fed is giving that problem deep consideration.

Let's not forget Adam Smith and the invisible hand. Of course people always forget about his comments on cartels, monopolies, duopolies and social responsibility.

These days people refuse to refine knowledge or create knowledge they just parrot some thought from the past and present it as their own(new).

Let's not judge a system by just how old it is. After all, one of our key analytical tools for working out the area of a circle is over 2000 years old.

I'm with Lithel. The question isn't the age of the idea, it's whether it's been refined, superseded, refuted, or what. If it's withstood all challenges to its validity for 106 years, and demonstrated its relevance to economic decision-making, then it belongs in the toolkit.

"Knut Wicksell" brings up a good question. Is there a good answer to it?

Ok, this may be a not a dead hit on the topic but it *is* about the Federal Reserve and the way they think. MSN.Com just posted a report saying housing prices are truly and well bubbled. The author of the report are the economists from

>HSBC, a giant bank and financial services company,

The article delineates this as an argument with the Fed, which apparently just said there was "little evidence" to it.

Now I have suspicions but sure don't know enough to say who's right. I do admit a unwholesome desire to see our less-thoughtful righties try to defend Alan Greenspan (a government-paid bureaucrat) against these people, who by conservative orthodoxy must be some of the finest in their field anywhere, having landed 6-figure (at least, I bet) jobs at the heart of an enormously successful company.

Ahem, now I truly am off topic. But: If this post causes a massive thread hijack on housing I apologize. Yet, Brad's opening was in a general sense about how the Feds think about things, which nobody but economists care about.

But are they thinking in the right way! This is something everybody in the world desperately cares about....

And apparently a few sharp guys aren't seeing what the Fed sees. Not comforting.

Maybe the Fed needs to have a secret think tank devoted to analyzing and critiquing the thought. Wait, that is already provided by the Mises institute, and widely ignored. The Fed is never wrong, until proven spectacularly wrong. Anyone for a little coup of whiskey? All the world is a stage, and AG is at the center of his. No heart attacks, please. conversely then we should be growing our money supply by some Lucasian/Friedman ratio including what we desire as the "natural" rate of inflation. Of course we aren't doing this. Check out the FRB's own statistics on the hard money supply growth. Skip the M3 and the other soft measures and look at the 40% growth since 2000. Don't cry for me Argentina.

Maybe the Fed needs to have a secret think tank devoted to analyzing and critiquing the thought. Wait, that is already provided by the Mises institute, and widely ignored. The Fed is never wrong, until proven spectacularly wrong. Anyone for a little coup of whiskey? All the world is a stage, and AG is at the center of his. No heart attacks, please. conversely then we should be growing our money supply by some Lucasian/Friedman ratio including what we desire as the "natural" rate of inflation. Of course we aren't doing this. Check out the FRB's own statistics on the hard money supply growth. Skip the M3 and the other soft measures and look at the 40% growth since 2000. Don't cry for me Argentina.

I'll take Wicksell over Keynes any day. Oops, don't mean to offend the Keynesians here.

Dibs on all the "you can't turn back the tide" Knut jokes during the current interest rate cycle, as well as the more obvious and less printable ones.

I've always thought that one of the most cogent interpretations of what Keynes is all about is Leijonhufvud's *On Keynesian Economics and the Economics of Keynes*. One message of the book is that Keynes was a Wicksellian who simply added the idea that real income, not just prices, change when the monetary rate differs from the natural rate. In L's reading, Keynes thought the major problem of his time was that a fall in the Marginal efficiency of investment left the actual interest rate above the new lower natural rate; that bear speculation prevented the actual rate from falling; that this in turn led to falls in real income - as saving exceeded investment at the higher-than-natural interest rate; and finally, that the fall in saving with income made the bear speculation self-fullfilling, so that the interest rate would remain too high even without speculation.

But maybe Brad's point is that the Fed's appeal to Wicksell leaves out all the Keynesian innovations, so we're back in a world where only lousy monetary policy (not speculation) leads to gaps between actual and natural rates; and where the consequences of such a gap are confined to price changes, so that W's cumulative process is purely nominal. I would agree that if this is what the Fed's use of Wicksell is all about, then we do indeed have a regression of knowledge (something I've always been skeptical about in the rationale's for real business cycle accounts of the cycle!).

Still, I think L is right that Keynes took from Knut the idea that deviations of actual from natural rates are at the heart of the macroeconomic problem.

ps: my favorite Wicksellian is D H Robertson!

We all live in wicksellian world.

When Knut referred to a natural rate, back 106 years ago, he was referring to a lively market mechanism he could probably see at work (even if indirectly). Now, thanks in part to his own contribution and suggestions, such mechanism has long been extinct. The fixing of rates has been a policy business for ages, and market forces have little to do with it. Are we sure that we can still attribute the same informational content to such abstraction? Or has it become too thin ?

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The idea of the natural rate of interest is actually 202 years old; Henry Thornton discusses it (or something much like it) in his Enquiry into the Nature and Effects of the Paper Credit of Great Britain (1802). For an analysis, see this article from a Federal Reserve Bank of Richmond economist:

http://www.rich.frb.org/pubs/ereview/pdfs/ER720303.pdf

A book that explains how to apply Wicksellian ideas to guide contempoary central bank policy is Manuel H. Johnson and Robert E. Keleher, Monetary Policy, A Market Price Approach (1996). It is available from the usual new- and used-book sources. Johnson was vice chairman of the Federal Reserve Board of Governors from 1986-1990 and Keleher was an economist there.

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Get it up mate, it's fun!

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