Re: Current (heterodox) thinking on interest rates?

[Jim Devine <jdevine@xxxxxxxxxxxxxxx>]

At 01:22 PM 04/02/2000 -0500, Barnet wrote:
> Perhaps someone could summarize (or supply citations on) current
> (heterodox) thinking on interest rate determination
> (in the U.S.).

I'm no expert on the heterodox thinking on this subject, but I would point
to Marx as a good place to start. Marx rejected the idea that the interest
rate could be determined by labor-value (so that there was no "natural rate
of interest" analogous to Smithian "natural prices," prices of production).
Basically, for Marx, interest rates are determined by the supply and demand
for funds. However, there were limits to the fluctuations of supply and
demand. Marx saw interest rates as being limited by zero and by the profit
rate (though this upper limit is not absolute, since interest rates have
relative autonomy). On average in the long run, as I understand Marx, the
relationship between interest and profit of enterprise depends on the
balance of power between banker's capital and industrial/commercial
capital. In the cycle, interest rates are pro-cyclical, with the interest
rate soaring to the stars in a financial crisis, and then falling as the
demand for loans falls in a recession.

I think Keynes' contribution (the theory of liquidity) was important. So
non-liquid assets must pay an illiquity premium. I think also that the
Keynesian shift to an emphasis on the stocks of assets rather than the
flows of funds has something to add.

> Seat of the pants empiricism suggests that everything just follows the
> discount rate but there's probably a better story.

The discount rate (and more importantly, the fed funds (interbank) rate) do
have an impact on other interest rates. But there are various premia that
make the expected long-term real interest rate (the most important rate for
determining long-term investment) change relative to the short-term nominal
rate. The risk/maturity/illiquidity premium on long-term rates vis-a-vis
short-term rates can vary as  economic conditions change. For example,
circa 1992, the "yield curve" (mapping yields to maturity vs. term to
maturity of different treasury issues) got very steep as pessimism about
corporate, bank debt, and the like. This meant that low short-term nominal
rates didn't stimulate the economy for quite awhile, making it hard for
Bush to win reelection (I'm pretty sure he lost, but it's hard to tell
sometimes) and easy for us to talk about a "jobless recovery." (The steep
yield curve also meant that banks could borrow on the cheap and lend
profitability, while corporations could refinance their debts at lower
rates, so that this barrier went away for awhile.) Also, real and nominal
interest rates differ according to expected inflation rates.

The above is pretty standard. In fact, a good explanation appears in an
intermediate macroeconomics text by Martin Neil Baily & (first name
forgotten) Friedman. The former heads the US Council of Economic Advisers
these days, I believe. Maybe you should look at the NEW PALGRAVE or Phil
O'Hara's ENCYCLOPEDIA OF POLITICAL ECONOMY. I've heard that Doug Henwood
has a book that touches on these issues, too.


Jim Devine jdevine@xxxxxxx & http://liberalarts.lmu.edu/~JDevine/JDevine.html