Jim, When I have looked into the background of the conceptual definition of the "real interest rate", I have found that (1) it changes across time, (2) different authors use many different "key" interest rates to represent the "real interest rate" (for example, a 3-month Treasury Bill or a five-year bill, or a full mortgage etc.). (3) There is no real agreement about the details of the calculation of the statistic.
It is true that the nominal interest rate for particular types of government securities is fixed by regulation, but certainly e.g. for mortgages or credit cards what is economically significant is a statistic of the average interest rates. It is all really pretty political stuff, since obviously different groups of economic actors are affected most by different types of interest rates, as I already suggested earlier. What most economics authors have in common, is that they try to find a concept of the "true cost of borrowing". You have the famous (but trivial) Fisher equation (after Irving Fisher), where the nominal interest rate = the real interest rate + the expected inflation rate, so that the real interest rate = the nominal interest rate minus the expected interest rate, and so on. (You already mentioned ex post and ex ante definitions.) Point is, what the real cost of borrowing is thought to be, will depend on your choice of rate types, and on your inflation assumptions (never mind tax and ancillary charges). Now what bankers and IMF people try to do, for example, is to establish a "neutral real interest rate" (NRIR) for the purpose of a macroeconomic analysis that can inform monetary policy. They claim sometimes that this concept originates with the Swedish economist Knut Wicksell's rent theory (they don't seem to like Keynes that much). Wicksell was supposed to be the first to define the "natural real interest rate" as the rate at which savings and investment are equal (which supposedly would be non-inflationary, hence the rate is "neutral"), which in turn, assuming no frictional disturbances, would equal the marginal product of capital in the long-run (?). A shortrun NRIR could similarly be conceptualized assuming stable inflation and a zero output gap, and what bank analysts then try to do - this is all within the framework of equilibrium economics - is to relate the actual interest rates there are, to their estimate of the NRIR, i.e. roughly, the hypothetical interest rate that would obtain, if inflation was stable, and if there was no gap between potential output and actual output (or, if you like, between actual GDP and potential GDP). If you can know the ratio of the actual interest rates to the NRIR, then you have an evidential basis for policy advice to the effect that, if the actual rates were higher or lower, then that this would promote the fullest use of the factors of production. Alan Blinder for example theorizes, "if the real interest rate is below the neutral rate, aggregate demand will eventually exceed potential GDP, leading to higher inflation. Conversely, a real interest rate above neutral will ultimately be disinflationary". Blinder offers a Fed anecdote to illustrate his NRIR idea: "To tie these ideas to real events, consider Federal Reserve policy since the 1990-1991 recession. Gradually and, some might say, grudgingly, the Fed lowered the federal funds rate to 3%-which was about zero in real terms-in a lengthy series of steps culminating in the fall of 1992. As zero is well below the neutral rate by anyone's reckoning, monetary policy was clearly very stimulative. With a lag, the U.S. economy responded. Then, in February 1994, the Fed started moving the funds rate back toward neutral-explicitly calling attention to that concept as part of its justification. The nominal funds rate eventually peaked at 6%-which translated into a real rate slightly above 3%- in February 1995. That would be on the "tight" side of neutral by most-though not necessarily all-estimates. And the Fed held that rate until July 1995, when it began a three-step easing that brought Federal funds down to 5.25% on the last day of January 1996. With inflation running in the 2.5%-3% range, that meant a real rate between 2.25% and 2.75%- which was probably either neutral or just slightly on the tight side. Chairman Alan Greenspan explicitly acknowledged this in Congressional testimony in February 1997, when he said: "The real funds rate might be at a level that will promote continued non-inflationary growth." But a month later he hedged his bet by nudging the Federal funds rate up another 25 basis points, where it remained as this book went to press." (1998, p. 35) The scientific question that arises is: how can such an NRIR computation exercise possibly be objective? The analysts admit it is a difficult exercise. The NRIR is "not an observable variable", the IMF admits, so there is not just one way to estimate it. The NRIR "could change over time". Alan Blinder (Central Banking in Theory and Practice, 1998, p. 33) says the NRIR is "difficult to estimate and impossible to know with precision." Nevertheless Blinder recommends that central banks should compute an NRIR! The point here is that the bank economists end up thinking that something like the NRIR really exists, even although they cannot measure it "exactly." In fact they cannot measure it at all, since they are dealing with an "unobservable variable" and the measurement attempt involves rafts of assumptions and extrapolations. It is really a pure theoretical dogma (an unverifiable assumption), along the lines of: "at any time there exists a real rate of interest at which the fullest use of factors of production will be made." You say: To say that the "real" interest rate "doesn't have any real existence or influence as a social force" is saying that real-world people making inter-temporal decisions under conditions of moderate or greater inflation do not know that the money they pay back (or receive) in the future will have a lower ability to buy real goods and services than money borrowed (or loaned) right now or do not make any decisions based on that knowledge. What I meant is, that what influences people is only the "actual, observable rates of interest", and not a theoretical rate of interest. I do not deny at all, that people can recognize the reducing buying power of money, and its effect on their loan repayment. But probably most people are not such rational actors as economics makes them out to be - the main effect is, that they sense they are a bit more constrained in what they can spend, or reschedule their mortgage. J.
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