Monday, 23 March 2015

The "Natural Interest Rate" Is Always Positive and Cannot Be Negative

By Thorsten Polleit

Some economists have been arguing that the “equilibrium real interest rate” (that is the “natural interest rate” or the “originary interest rate”) has become negative, as a “secular stagnation” has allegedly caused a “savings glut.”

The idea is that savings exceed investment, and that a negative real interest rate is required for bringing savings in line with investment. From the viewpoint of the Austrian school, the notion of a “negative equilibrium real interest rate” doesn’t make sense at all.

To show this, let us develop the case step by step. To start with, one should make a distinction between two types of interest rates: There is the market interest rate, and there is the originary interest rate.

The market interest rate is the outcome of the supply of and demand for savings in the market place. It can be observed, for instance, in the deposit, bond, or loan market for different maturities and credit qualities.

The originary interest rate is a category of human action, saying that acting man values goods available at present more highly than goods available in the future. In other words: Future goods trade at a price discount relative to present goods. For instance, 1 US$ available today is preferred over 1 US$ available in one year’s time.


If 1 US$ to be received in one year’s time is valued at, say, 0.909 US$, the originary rate of interest is 10 percent. (1 US$ divided by 0.909 minus 1 gives you 0.10, or 10 percent, for that matter.) 10 percent is here the originary interest rate (disregarding any other premia).