catallaxy files

catallaxy in technical exile

Keynes and Australia (and Knut Wicksell on the NRI)

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This paper on Keynes and Australia looks like fun although I have not had time to read it yet.

It turned up in the Keynes section of the History of Economic Thought site which looks like a handy reference although it is terribly biased to Keynes and is threadbare in parts, for example it only lists the publications of Knut Wicksell without any indication of his contribution, or that of the Swedish School.

A really interesting group is the Vienna Colloquium, convened by Karl Menger, son of Carl, from whence sprang games theory and general equilibrium theory. A parallel symposium that was mostly concerned with probability theory was convened by Richard Mises, brother of Ludwig. Popper was involved with both these groups where he had some recognition that was denied at the Vienna Circle of Logical Positivists where he was never invited to the inner circle.

Getting back to Knut Wicksell, it seems that he invented the Natural Rate of Interest NRI which Friedman matched in more recent times with the Natural Rate of Unemployment NRU. From a recent paper integrating various theories of the business cycle.

Two Natural Rates
The natural rate of interest (NRI) is the “rate of interest on loans which is neutral in respect to commodity prices, and tends 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” (Wicksell [1898] 1965, 102). From a slightly different perspective, the NRI is the rate “at which the length of the roundabout methods of production is extended just so far that it can be
supported with the available subsistence fund” (emphasis in original) (Strigl [1934] 2000, 114). In terms perhaps more familiar to most present-day economists, one can think of the NRI as that rate of interest at which ex ante investment equals ex ante saving.

The natural rate of unemployment (NRU) was introduced by Milton Friedman “to parallel Knut Wicksell’s ‘natural rate of interest’ “(1977, 458). Like the NRI, the NRU reflects the underlying real variables in the economy, not the possible distortions brought on by certain monetary policies. The NRU is not a constant “but depends on ‘real’ as opposed to monetary factors—the effectiveness of the labor market, the extent of competition or monopoly, the barriers or encouragements to working in various occupations, and so on” (Friedman 1977, 458). Interestingly, Friedman goes on to make reference to a “forced-draft economy” that induces workers to “sacrifice leisure for goods that they value less highly than the leisure” (1977, 459). The significance of this latter comment is that it reveals Friedman’s (at least implicit) awareness of time preference as an important part of the supply of labor.

Clearly, leisure is a present good, and labor is a means to acquire future goods. Since the rate of time preference is the rate at one prefers to trade present goods for future goods, then workers’ decisions are a reflection of their time preferences. Friedman has identified the fact that, if the expected real wage rate differs from the actual real wage rate, then workers’ allocations of labor versus leisure will depart from their preferred allocations. Actual economic conditions will be inconsistent with time preferences. And those economic conditions will be unsustainable (Friedman 1977, 457).


Written by Admin

December 6, 2005 at 11:37 pm

Posted in Uncategorized

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