Statistical Surveys and Non-Response Errors

Survey Non-Response

The purpose of this post is to address the concepts and issues behind non-responses in the survey. When economists or any researchers are collecting data for an academic or statistical study, non-response is becoming a more prevalent issue. Hence data collection needs to adapt to societal changes to maintain a level of academic rigor.

There are two types of non-response

  1. Unit non-response
  2. Item non-response

Either one can be selective non-response, which is a systematic difference. Systematic non-response is a severe statistical problem because of a group of responders can effectively invalidate a study. Below I give a hypothetical scenario that shows some of the reasons for non-response comes about in research.

Surveys have statistical issues

An illustration of Non-Response – Nutritional Adequacy of Low-Income Earners in the Rural US

To illustrate better the reasons for non-response, consider a survey that involves low-income earners in rural America. For example, if a researcher is studying the nutritional adequacy of low-income households, and when the household head tends to be female, there is a higher occurrence of non-response compared to other demographic categories. This means results for female lead households could be radically different from two-parent households simply because of sampling error. Therefore, with fewer female lead household responders, the data might not be as statistically rigorous for this category, and therefore, the study as a whole. Let us look at why there might be non-response in this category more than other categories.

With a male at home, many rural Americans grow their own food.

A Hypothetical case study from Rural America

Safety concerns of interviewee might result in non-response

In the case of one parent female lead households, women have safety concerns to identify themselves as the only adult at home, in rural areas. Therefore, single-parent females might not reply. The result is a systematic non-response. However, the nutritional profile, in reality, is different in a household when a male is present.

Additionally, this data skewing might be exacerbated in the following case. In the USA, many low-income rural households grow food and hunt and fishing for food, themselves when the male is present. (This was similar to the situation when in Poland during communism, people in the countryside often had land or domesticated animals, and this contributed to nutritional adequacy people in the city might not have access to through the standard economic system).

Therefore in the Rural US, even though incomes are low, they have moderate to high-level nutritional adequacy because of self-sufficiency coming from the land. This is even encouraged as Supplemental Nutrition Assistance Program (SNAP) benefits for food can be used to purchase seeds, plants, and trees for a backyard food plot.

People in the rural US like Appalachia, Texas, the Deep South, and the Mountain regions, have cultural values of self-sufficiency. Homesteads grow corn, have a garden, have an orchard, hunt, farm catfish, raise a chicken, pigs, or have a cow for milk, cheese, and yogurt. (Author’s note: I live in a rural area, and I personally have a sugar cane field, potato field, a garden, and a fig orchard.) 

However, single mothers do not have the time or opportunity to engage in non-income producing primary sector activities, and they and their families have lower nutritional adequacy because of their dependence on a traditional monetary economy. Because of family responsibilities, the opportunity cost of agricultural self-sufficiency is too high to take on themselves. Therefore, they do not have the same access to food as rural households with a male present (the same could be the case with male single-family households).

The result is more inadequate nutrition for household lead by single parents. Specifically, government low-income nutritional programs for families and mothers like the Special Supplemental Nutrition Program for Women, Infants, and Children (USDA WIC) specify household food purchases on this program must be the cheapest quality food because of the program’s budget restrictions. For example, milk must be the lowest price and low-fat (which is not optimal because of the need for growing children and nursing mothers to have fat for their brain development). Also, produce needs to be inorganic as does the bread. Therefore, low-income mothers are living on hormone-treated milk, white bread, and canned produce grown in soil lacking micronutrients such as chromium or selenium. These diets might be sufficient in macronutrients like protein and carbohydrates but lacking in micronutrients, which are a catalyst for health.

However, the issue here as it relates to the researcher and study is, the female head of households will not reply in a survey as mentioned above for safety reasons or feelings of self-esteem. There is also distrust/belief in the government system, which can take their children away and put them in a foster home if the state feels the family can not provide for the children, as can be the case in the United States.

Therefore, the study will show that the overall level of nutrition for low-income earners is adequate if you polled the composition and nutritional components of a family’s daily diet of low-income earners. This is because it might underrepresent the female head of households because of non-response.

That is, the case is because female lead single-parent homes are not statistically represented in an academically rigorous way, because of non-response. However, they are arguably the most important category of the study as there is a disproportional number of single parents in poverty. Statisticians and surveyors/data collectors, therefore, must overcome or account for this non-response to make it a meaningful study.

Rural single mothers have a large non-response

How can non-response be mitigated in this case

Ways to overcome this non-response might be a simple as hiring local trusted and known female surveyors that can go door to do. If interviewers are known in the community and mirror the demographic, in this case, female to female and a single mother themselves, the response rate tends to be higher. Also, assure the single mothers this is anonymous, and the survey is not to be used by Child Services to determine parental adequacy. Alternatively, give monetary incentives. 

Another way to mitigate is simply over-sample. By over-sampling when statisticians collate the data, there, adjustments could be made if done correctly.

It can be noted there is also Non-selective non-response but no reason that there is a difference between respondents and non-response. 

Why non-response errors are impactful

Non-response errors affect sample size and outcomes. Sample different than the entire population. It does not represent the population in a meaningful way. Needs to represent the population and non-response sampling errors can alter this.

  1. Reduction in sample size – Statistical issues, as noted above, larger sample sizes are associated with measures closer to the whole population.
  2. Unwilling participants can skew the results. The answers from the pool of responders can be different than the pool of non-responders. Each group has a different reason. Non-response bias, a particular group, is underrepresented or not represented. 
  3. Item non-response – In some cases, a particular group or demographic might respond; however, on specific questions, they might non-respond. Not replying to specific items can create an under response, which can also distort the result.

Reasons why there are non-response errors

The reasons for non-response ultimately is based on the psychology of the individual. That is their perception of the survey in the context of their defined situation.

  1.  Formal social categories (age, gender, race, political parties, religion, education level, race)
  2. Limiting social factors ( crime, extreme poverty, health, cognitive or technology deficiencies)
  3. Survey settings (meeting in person, personal appearance, subconscious signals).
  4. Survey privacy is an issue (concerns if the survey is anonymous, and the researcher protects personal data and any connection to the individual).
  5. Lack of clarity in the question can result in less response (ambiguity can lead to non-response).
  6. The mode of data collection is significant when constructing the survey. The researcher must be cognizant that the objective is accuracy, not just convenience (technology fluent individuals compared to less tech-savvy, or door to door, for example, some people might not open their door or answer their phones as a rule).
  7. Could be seen as invasive or offensive questions
  8. Psychological reasons

How to reduce non-response

  1. Try to understand the reasons for non-response in one’s particular case
  2. The chosen interviewer could mirror the demographics of the interviewee. For example, if part of the study looks at older Hispanic Males, the interviewer could be an older Hispanic male. In contrast, younger Caucasian females might not be relatable to the interviewee.
  3. Include visual graphics to explain and simplify the purpose and questions.
  4. Oversampling
  5. Dress professional can and a congenial, professional attitude
  6. Economic incentives (such as a chance to win a Starbucks gift card if you reply).
  7. Follow up.
  8. Have a clear privacy policy, and ensures data is anonymous.
  9. Have the timing of the call or interview respondent centered rather than researcher convenient.
  10. Before the use of the questionnaire, do a user testing for clarity before the release. This way, you have feedback on how to improve the sample questionnaire for higher response. This allows researchers to improve on their mode and format and clarity of the questions.
  11. Give respondents multiple ways to respond, such as email or post.
  12. Give a clear summary of the importance of the research. That is why the study will be beneficial to society as a whole.

An Economist’s 2020 Presidential Election Guide

This is an objective guide to the US 2020 Presidential election from an economist ‘s standpoint. Since the economy is the number one determinate criteria for people voting on the margin, and will swing election results, I think a guide to US economic issues is relevant. I also have a brief candidate guide to the 2020 election at the end.

The problem is politicians do not understand the issues, and many economists are clouded by political bias. In contrast I do not like politics and will tell it like it is. You can debate me in the comments.

  • I teach college and getting a Ph.D. in Economics with a focus on monetary economics.
  • The following are the issues the politicians and economics will not tell you but are the reasons behind the economy.
  • The election 2020 will come down to two candidates. Trump versus Sanders or Biden. Bloomberg is an elitist and not electable.

Main economic issues in the 2020 election:

  • Worker pay – Medium income is up, but is it?
  • Government spending – We have a one-party system.
  • Inequality – Wealth is up, but for the rich.
  • Taxes – Everyone has their view of what is fair.
  • Unemployment – In the US, underemployment is the issue. A lot of talented people working for peanuts.
  • Inflation – If you define inflation as the CPI, there is nothing to see here, but if you look at the real world, you will see a different picture.

Worker Pay in the US

Real worker pay is an average pay, which is put in real dollar terms when compared to the CPI. However, there are two problems with this:

This is an aggregate number and means nothing unless you look at the Gini Ratio. Also is is fueled by debt when the next crisis comes it will turn down.

The CPI is a narrow measure of prices. They measure only a slice of the pie, with known statistical flaws. Therefore, the defined and measured CPI does not reflect what you are experiencing at home. Hence, your real income might be down compared to your parents. For example, medical and college tuition is astronomical. Real Estate is hardly debatable, for example, my ‘poor’ immigrant grandparent’s townhouse is worth a million dollars today. Even a home built in the 1900s was better quality and had more land than a cookie-cutter HOA homes of today. The average age of first time home buyers today is plus twenty years than it was way back when, and steep mortgage with student debt and credit card debt.

It also does not account for the substitution effect. That is, people are substituting organic or at least locally grown apples with heavily sprayed low-quality apples from abroad (e.g. Mexico and China). With my ‘poor’ immigrant grandparents, everything was organic and local, and the milk was delivered their door. Therefore, it is not an apple to apple comparison for any product. Therefore, using the CPI to measure ‘real’ income is not a factual representation of people’s real buying power.

The number is an average. Since we know the Gini co-efficient is increasing, and this indicates the rich are getting richer and the poor poorer, the question is why? High-income earners skew the statistics. Yes the average is up, but because the super rich have more not the middle class or poor.

You need to be objective and think critically when looking at economic statistics.

In conclusion. even with with the biggest boom of all times, we are about equal in real income to the 1990s if you look at the Federal Reserve data and do not question it like I have above. I do not think we are better off in America considering wealth effect goes to the high income earners and a negative wealth effect goes to Xers, Millennials and generation Zs who are students are highly in debt getting inferior educations and do not have that first home,but do have a long commute. If the bubble bursts then real income will again decrease and veil will be removed from the economy.

Money is the second half of every economic transaction

What can be done to fix the lack of real income growth for the middle class? A large part of the problem with the lack of real income growth is monetary, that is connected to the Federal Reserve Bank. This is abstract and that is why politicians in the 2020 election will not address it. They do not understand it or can not make a campaign slogan out of it.

Can you image the slogan “money is the second half of every transaction… and central bank policy exacerbates the income disparity’.

Both the Republicans and the Democrats support central banking and stimulus policy. Therefore, no matter who gets elected this will not have a large impact on your paycheck. Non free market fiat money is the problem in the economy and without a “sound money” policy you will not get ahead and it will perpetuate inequality and a business cycle. You can debate me on this, but it is true.

For your paycheck to increase, we need to eliminate the Federal Reserve, so actual savings is connected to real investment. No capital goods or real prosperity were ever created with printing paper money.

Low interest rates create mal-investment that distort the capital structure. People who should not get money get money. The money is pumped into the system to keep the aggregate numbers looking stable. But they are not.

President Trump is a little closer to eliminating the Federal Reserve bank than the Democrats, however, it will not happen. Evidence is how he has a few quasi Gold standard appointments to the Central bank.

However, he will not follow through with the elimination of the Federal Reserve as he does not have the courage or understanding too. As much of a maverick he puts himself out there as, he is not, because he the government has a stranglehold on money, but the Democrats are not any better.

All other issues like import restrictions and tax cuts or raising the minimum wage are for economics 101 students to debate. The real issues is we have free market in every commodity except the most important, money.

Government Spending

There is a point soon we will not be able to pay interest on the debt. If Rates rise, or recession, this gets worse.

The debt clock is clocking in around 23 trillion, and this does not include state, local, corporate, or personal debt. Everything around you is funding by debt. With the debt and the deficit, neither party will cut. They keep saying we will grow out of it. I am an honest economist. We will not.

Read my lips. The government cannot grow their way out of the debt bubble. We are in an economic boom and the debt has increased. The boom will stop and the debt will expand.

Do not get upset if I write the truth below. Rather debate me in the comments.

Trump is a Keynesian like Obama and Bush as will be any Democratic choice for President. Trump understand free market economics, but practices government expansion. His 34 Billion dollar increase for more tanks and flamethrowers could have been allocated back to your family.

His spending increases are funneled to the special interest of war. The issues is we do not have a legally declared war.

The Democrats will not cut military spending either. So do not think if you vote Democrat you will get some kind off shift of resources from tanks to food, science and education. It will not happen. You will get an increase in both. Military spending is almost a religion in the US and the drum beating takes advantage of people’s real love for this country. Military spending, if you include benefits, is about 2/3 of the discretionary budget. I am a conservative patriot, yet I am looking at this honestly and objectively.

Every gun that is made, every warship launched, every rocket fired signifies, in the final sense, a theft from those who hunger and are not fed, those who are cold and are not clothed.

5 Star General, President, Supreme Allied Commander WWII – Eisenhower

1984 one party system

Because I am a Patriot I can call this out: The Republic has been replaced by an Empire.

Ancient Rome, the British Empire under King George III or the Russians and Chinese today, spend a fraction of what we do on military in percentage terms.

Defense is when someone invades your country, and congress legally declares war and respects article 8 of the US constitution about a standing army. We have an empire and like England had a mantra ‘make the world England’ with Kind George III. We have a similar mantra to make the world like the US, ‘safe for democracy’. The issue is it is making you poor and the US weak. A country is strong because of its technological advantage. This comes from the free market not government. Debate me on this in the comments as I am a patriot.

If we spend 1 Trillion a year in the US, on science or just give it back to you, we would have flying cars by now and cure countless childhood diseases.

Only Libertarians understand the spending issue, unless someone can show me a candidate in the 2020 election that would cut the military down to the constitutional understanding. Have we become the empire the American revolution stood against?

Spending on social security and medicare are much more complex and beyond the of this article. However, both the Democrats and the GOP have ‘ideas’, yet neither would have an impact, unless it was privatized.

Health care as an economic issues depends on one simple question: Do you believe in social medicine? I do not believe central planning improves what the collective unconsciousness of individuals can achieve.

I personally go aboard for basic health care and pay cash because it is so expensive in the US. Better is to have a free-market health care system in the US and then it would be affordable as the market would create pricing for low and high-income individuals, just like there is a store like Walmart for others. Trump supports a free market in health care.

The Democrats want to make health care their issues as it buys votes. But the reality is, it would make decrease the quality of care.

We are heading towards the debt wall at an accelerated pace. Therefore, for the 2020 election it does not matter as Presidential candidate who is a contender, understands it or is serious about it.


When the Central Bank ‘creates money out of thin air’ someone wins and someone loses.

Several factors cause income inequality. A minimum wage increase helps some and hurts others. The primary driver of the disparity in the US right now is the Federal Reserve or the central bank.

This is hard to believe unless you understand the issue.

The primary driver for this inequality that can be easily controlled is central bank monetary policy; that is, there is always a ‘first and ‘last’ receivers of money. The Fed pumps money into the system into 30 select banks, and this trickles down. The ‘first receivers benefit and the ‘last receivers’ do not. This creates inequality. Unless they when they pump money they would instantaneous and proportionally transformer it into your bank account the money of every US citizen, which would not happen, it is an unfair distribution.

It does to the fat-cats and big-wigs as the central bankers twirl their mustaches and drink lemon flavored ice water in cushy conference rooms.

Most people in politics in the US do not understand this. There is always a first and last receiver of monetary policy. When monetary policy is transmitted, this exacerbates the Gini coefficient and creates inequality. The net result is you have the super-rich and everyone else.

Minimum wage or more rules or regulations are a drop in the bucket compared to the problem of money. I would say global competition and other factors are in play, however, the market should level the playing field through arbitrage coupled with increasing opportunities and education for all. Yet, there needs to be something to sustain and perpetuate inequality.

If the US were on a gold standard, income distribution would improve overnight. It would not be a utopia, however, real savings would be connected to real investment, rather than monetary pumping.

The Democrats and Republicans will not address this. Perhaps Trump might if he sweeps congress in 2020. So that would be a check-mark in his favor, but I am skeptical until he makes definitive statements towards this.

However, if you try to redistribute income via the tax system, this results in slower growth for all. This is a Democratic idea. It does help to some extent, but not a long-run solution.


Taxes are not the issue; it is spending. I favor a progressive tax system, but better would be to cut government spending 90%.

No nation was ever taxed into prosperity. We need a balanced budget amendment.

Trump made progress by cutting the corporate tax. This does create jobs. However, it is not enough. He transferred it to the US debt. If we cut taxes for the middle class and the impoverished by the same about it might have a similar effect. I would say the Democrats have a check-mark on tax cuts. There are a few candidates that want to balance the budget.

Ultimately we need a balanced budget amendment. Neither political party will support this or they will exclude military from any cuts. They would say yes balanced budget excluding military and this mean that spending on that sector would increase.


This is not an issue in the US for the 2020 election. It will become an issue if the US raises interest rates. What is the problem is everyone is thrilled to get a 15 dollar an hour job. I am getting a Ph.D. in Economics and Finance and 20+ years of consulting experience, and I get paid OK. I know a lot of people with a college degree that are waitresses.

Underemployment is the issue. The solution to have a basic life is debt. You can not claim the economy is healthy if the country is underemployed, worker force participation is low, and debt is increasing. Even me, I ride credit card debt.

President Trump is trying to help this with fairer trade practices. Yet, to some extent, it is the fact that we are now competing with the whole world, there is no way to stop it and it is very competitive out there.

Less people working and the people who are are working for less.


In a technologically developing economy, as thing more organized and efficient you should see deflation. To prevent this with an arbitrary target of 2% inflation goal, distorts the capital structure and perpetuates the boom bust cycle as articulated by Austrian Business Cycle theory.

Federal Reserve Bank goals are are contrary to the a free market. Can you image the government setting a goal that every apartment rent in the US should be $1,000 a month? Or oil prices should be set at $3 a gallon at the pump to create stability. Let the markets work.

Inflation is not the measured CPI. It is what you personally experience. Neither party can address this. Prices are determined by the market. In a growing economy, there should be deflation as production becomes more efficient. The Central bank does not allow this to happen and inflates the economy and distorts the capital structure. Prices are up and you are told by the government there is no inflation, but what do you think?

If you want to compare your living standard to the world or others in the US, go here: Cost of living comparison. It is created by actual user data.

Since the conclusion of the above post is neither party, Democrat or Republican has any wisdom on economics issues and only harms the economy generally with spending and debt, then I will vote on non-economic issues. I am an Economist and I see little difference in policy between the two parties. At this juncture, I will vote Republican (life issues) or Libertarian.

2020 Presidential Election Candidates

Donald Trump – The de facto GOP nominee, if the economy is stable he will get reelected. If not he will not. As a rough prognostication, if unemployment is below 4.4% in November of 2020 then Trump wins. If he wins the US Congress Trump, could make changes, but until I see pronouncements such as ‘balance the budget or ‘eliminate the Fed’, I am not overly impressed. I understand he is against a wall of opposition, however, he never declared himself as the candidate that would return the US to small government. Full disclaimer, I will vote for him because of his political stance on ‘life’.

Bernie Sanders – He is the man to beat. He is a well-intentioned individual but a self-proclaimed ‘socialist’. It makes him un-electable. He has charisma. He may have appeal to under 30 voters, but they are the most undependable. If you see France as the ideal economic country, this is the candidate for you. Stirs emotions with an appeal to justice, but it is justice has the cost of surrendering individual liberties. The US with President Sanders would be better off if it was Colonel Sanders than Berrie.

Mike Bloomberg – Part of the New York Elite. He can throw money at the election and gain power. But bear in mind, he will try to do the same for the US. And throwing money at a problem does not solve it at its root.

Joe Biden – Pro stimulus in the 2008 crisis, but also voted for a balanced budget amendment in 1998. Subsequent voting record indicated big on spending. Biden would not be a game-changer for the economy, however, it would not destroy the US either economy either. More rational than Hilary Clinton towards the allocation of scares resources.

Elizabeth Warren – Break up tech companies and regulate the market. Would crash the economy.

Why cannot the Democrats get a life candidate who wants military cuts, free market and is family orientated? For example, even thought I am free market, I do not mind a universal basic income if the waste was cut out of the bureaucracy. For example, if every US citizen were to get $12,000 dollars a year from the government, this would save the US money by cutting other programs.

My Ranking of Candidates for President

  1. Trump
  2. Joe Biden

Libertarian Candidate for the 2020 Presidential election

If there was a realistic Libertarian Candidate for the 2020 Presidential election I would vote for them. With Adam Kokesh and Arvin Vohra as Libertarian candidates in 2020, I do not see their chances as realistic, even if they are idealist, perhaps they are too extreme. Rob Paul is currently the best embodiment of these ideals, though not a candidate. The idea is a belief that humans are innately good and if freedom is maximized society as a whole benefits on par with Adam Smith and the ideas of the founding fathers. In the end it is about making the world a better place.

I will update this post so subscribe and check back. I will watch the debates with anticipation and see if any candidates touch on any real economic issues.

Let me know if you find issue with anything I have written above. The GOP, Democrats do not understand economics from the 2020 election.


Can Money be Neutral?

Central banks pursue a policy of money neutrality. Except when they are seeking a monetary policy to steer the economy. Money neutrality means money has no impact on the workings of supply and demand in the real sector. That is, money is just a veil or a cloak. Money’s influence and function are to serve as a medium of exchange to calculate and facilitate natural market prices and forces.

[democracy id=”1″]

The way central banks pursue their stated goal of money neutrality is to harmonize the Fed Fund’s rate with the Natural rate of interest. Let us say for simplicity the Natural Rate is the rate of interest, which brings savings and investment in equilibrium ex-ante (it is always in balance ex-post).

However, it is not that simple. When you are referring to a large aggregate macroeconomy, it is not simply setting the market rate equal to the natural rate of interest. Here is why.

Money cannot be Neutral

The following are a summary of arguments of why money can not be neutral. To date there is no central banker or academic that can refute this in its totality. The reason we have a central bank is political rather than having a positive effect on the macro economy.

1. How you define the natural Rate of interest

Definitions of the natural rate vary and how you define it will change your model. For example, in natura marginal productivity on real mobile capital, price stability, I=S ex-ante also modern interpretations such as Woodford’s past, present and future flexible prices in contrast to the world of rigidities, Austrian time preference theory of interest. If you can not define it how can you target it?

Three posts on the natural rate of interest:

2. Empirical estimates are problematic

There exists multiple models and estimates, Holston-Laubach-Williams, and other competing models. Each one has a claim to a number, what the rate is at a point in time. How can they all be right? If you steer a ship and you are off a few degrees you will end up somewhere else dending on your model’s output.

However, more important a neutral rate of interest is paradoxically impossibility because of money’s influence is ubiquitous., on par with traveling faster than the speed of light.

Money is about real markets and real market prices than empirics. Money and real factors are intertwined so you can not have money neutrality or estimate this empirically. The natural rate is in a very real sense and fairy-tale. Therefore, estimates are not meaningful.

Econometrically it is challenging to estimate the natural rate of interest. It is beyond the scope of this post. However, Central banks believe that with the right formula’s and complicated equations, R-Star is a reasonably accurate measure of the natural rate of interest. I am skeptical for reasons laid out here: R-Star.

Therefore they target something that does not exist, except for at universities on backboards and books that win awards . However, and equilibrium rate of interest is not something in the world of real markets.

3. Multiple rates of interest

However, even if Central banks could estimate the natural rate of interest, there is the problem of the existence of multiple natural rates of interest. Again that is not within the scope of this discussion. (Pierro Straffa, 1932). Here is a further discussion on:

4. Interventions create a feedback loop

Each intervention creates an imbalance in a dynamic economy. Money/purchasing power enters the macro-economy in a specific path, which distorts the market and creates feedback.

Frequently interventions create a more complicated situation with estimating a neutral rate of interest. Even if they could pinpoint a rate that brings neutrality, they still have to maintain it and it is a moving target.

Interest is not neutral buoyancy like a bubble in a quiet pool of water but rather in a dynamic economy that has forces that go up or down simultaneously and instantly and simply trying to move the water influences the bubbles path. This is not neutrality.

Money is not injected to everyone equality

When money is pumped through the system it is not injected equality. Rather, there are first and last receivers.

Therefore, the point that I want to focus on is that money cannot be neutral because when the central bank decides it needs to expand or contract money or purchasing power in the economy, it does not do this by dropping money on people’s doorsteps by helicopters, or in modern speak drones.

Instead, monetary expansion occurs via the banking system. The central bank in the United States pumps money by lowing the Fed Funds rate (hypothetically in relation to the natural rate of interest).

The Fed Funds interest rate which banks lend reserve balances to each other overnight. This seems like a convoluted way to control the supply of purchasing power, however, it effectively increases or decreases the amount of purchasing power in circulation.

The issue here is the opportunity cost of holding money is different for those who are rich and those who are poor. The rich benefit first, as well as those closer to the money expansion process.

Time preference theory of interest

The time preference theory of interest states that the opportunity cost of saving money is lower for the wealthy. This is because they can make their monthly payments easier than those living on a minimal income. To save money for a poorer person is a much more difficult task.

Therefore, first receivers have more money and their time preference will be lower.

The last receivers or no receivers become poorer. The opportunity cost for them is higher.

This is a transfer of wealth, a wealth redistribution. This is not a neutral policy.

Therefore, if you inject money there will be winners and losers. This again is not a neutral rate policy.

If rates go up the first recipients will lose money and there will be a business cycle.

Any policy is not neutral as it involves a redistribution of wealth.
Therefore, the only way you can have a neutral money policy is if you have free markets.

Historical context of money neutrality

The conversation in modern thought originates with David Hume, but became predominate after Knut Wicksell’s work Interest and Price (1898), and Mises’s Money and Credit (1912) development of his theories. Hayek and Keynes discussed and further popularized the economic concept. Robert Lucas also had a discussion but within the context of the Phillips curve. Michael Woodford, does not discuss it in his 800 page book on Interest and Prices (2003) but rather he assumes it with his flexible price equilibrium. The Federal Reserve combines this with their FRB/US econometric model and the Taylor rule .

It is only the Austrian economists of today that directly and repeatedly challenge this concept, such as Murry Rothbard, Frank Shostak, Robert Murphy, William Butos, Steven Horowitz or Lawrence White.

Free banking is the only money neutrality

That is free banking where supply and demand for purchasing power are determined by the market rather than by a central authority. Here is a discussion on:

Can money be neutral? Not with the existence of the Federal Reserve. Central banks exacerbate the trade cycle by ensuring the money is not neutral in the short or long run. In contrast, a free market combined with free banking which allows for the organic nature of money to evolve and operate can be neutral. A classic gold standard is a close proxy also but free banking is almost synonymous with neutral money. With this, the economy would have a high growth path, lessen the Gini coefficient and have a money macro equilibrium path.


Multiple Natural Rates of Interest – Pierro Straffa

The natural rate of interest is a rate of interest that exists in , that if there were no use of money. The Wicksellian marginal productivity on capital in a barter economy.

This posts looks at the significance of multiple natural rates and offers one avenue to pursue for a solution.

R-Star the singular empirical natural rate of Interest

Why this is important? The Federal Reserve Bank targets R-star an empirical proxy for this rate to try to create equilibrium in the economy. That is, if the observable market rate, (the fed funds rate) equals the natural rate, (R-star for the central bank), then money should be neutral. This means prices will neither go up or down for monetary reasons and the economy should avoid a business cycles for monetary reasons.

These are generalizations and there are many contributors to this theory, however, you can find these ideas in Knut Wicksell, Friedrich Hayek, and Michael Woodford.

Therefore, if the natural rate of interest equals the market rate of interest the Federal Reserve generally postulates we will have money macro equilibrium. This point is debatable. However, it is a mainline Federal Reserve opinion and operational policy. It is important because it is core theory the central banks operate on.

For a more detailed discussion of R-star directly from the Federal Reserve you can find it here: R-Star the empirical Natural Rate of Interest.

However, despite the intricate models and mathematical proofs, there is a theoretical problem that has not been addressed. Specifically, there are multiple natural rates of interest.

In other words, instead of one wholly empirically derived rate of interest, there exists multiple natural rates of interest for each commodity. Each good, particularly capital goods has its own rate of interest.

This means that the central bank targeting one interest rate is an incorrect policy. What might be good for one capital good is not good for another. Therefore, at some point there will be a distortion in the entrepreneurial use of capital that can create a business cycle. The result is the natural rate of interest as a theoretical construct and its representative in the empirical world R-Star is on unsure footing to use for policy. Central banks around the world like the US Fed and the ECB do just that.

Multiple natural rates of interest issue for theory

This objection of multiple rates of interest was raised by Piero Sraffa (1932) specifically in response to Hayek’s Austrian business cycle theory (ABCT) developed from Mises (Theory of Money and Credit 1912).

The idea of multiple natural rates of interest by Sraffa was so devastating to ABCT theoretically it was never directly addressed. It was circumvented by both the Austrians and the Federal Reserve and notably when Michael Woodford (Interest and Prices 2003) resuscitated the Wicksellian idea.

Woodford does discuss multiple rates on interest is his paper on Financial Intermediation in 2010, but this is not the Sraffa’s multiple rates of interest. Rather this is simple a spread rate to account for frictions. Woodford focuses on rigidities and frictions into his model. However, his model is still based on an equilibrium rate of interest which has theoretical issues, such as multiple rates. Therefore, the model which the central bank bases policy has a weakness. Specifically articulated by Pierro Straffa in 1932.

It is not addressed by mainstream economists or Austrian Economists.

Is Straffa’s natural rate a Wicksellian rate?

The own rate of interest– the rate at which something exchanges for itself. A commodity rate of interest.

Straffa’s own rate is not a natural rate of interest as understood by Wicksell. However, for the critique of the theory the same argument would hold if it was a Wicksellian natural rate or an Straffa own rate.

That is, shoes, are not a form of capital that is generally used in the production process. Better are potatoes seeds. Potato seed would be something I see as mobile capital that could approximate a natural rate as understood by Wicksell. It is homogeneous but also functions as a commodity and capital for the production process.

Straffa on Multiple natural rates:

An essential confusion, is the belief that the divergence of rates is characteristic of a money economy […] If money did not exist, and loans were made in terms of all sorts of commodities, there would be a single rate which satisfies the conditions of equilibrium, but there might be at any one moment as many “natural” rates of interest as there are commodities, though they would not be “equilibrium” rates. […] if loans were made in wheat and farmers […] “arbitrarily changed” the quantity of wheat produced, the actual rate of interest on loans in terms of wheat would diverge from the rate on other commodities and there would be no single equilibrium rate.

(Sraffa 1932 p.49)

This divergence and the existence of multiple rates was a common phenomenon in a barter economy. Sraffa’s sees the divergence of the money rate and the natural rate as the divergence between the spot rate and the forward rate. However, in this case, it is still observed in a monetary economy. Money is still ubiquitous and flowing in every part of this economy. Even though he is analyzing essential commodities like cotton or wheat, it feels like a natural rate. But it is not, it is still in a world where all we see is money prices.

  • Sraffa does understand the dynamic nature of the economy that, changes in the production of a particular commodity can at least temporarily create changes in the natural rate between, so there are multiple natural rates.
  • Sraffa did see a convergence of commodity rates of interest when the economy was in equilibrium, in which all commodity rates were equal as well as the money rate.
  • Sraffa critiques Hayek by stating that the multiple naturals rates are not equilibrium, only when unified as one rate.

This is my first pass at an understanding of the multiple natural rate problem. A more in-depth article I might review latter is by Robert P. Murphy. Murphy has a suggested solution.

Multiple Interest Rates and Austrian Business Cycle Theory


Free Banking as an Alternative to the Federal Reserve

Free banking compared to Central Banking

Free banking is money that is issued by free-market private banks with minimal regulation and clear market rules in a competitive environment.

Free banking has worked throughout history, yet for ideologically derived and fiscal expansion reasons it is jettisoned for government-controlled money. The idea is a few intellectuals know better than the free market. We should trust the few intellectuals over our own wisdom.

Free Banking is the only method available for the prevention of the inherit expansion of credit.

Ludwig Von Mises, Human Action, p.440

Free banking in history

Banks historically back their currency with gold or silver. In this manor confidence in the currency was established. If you could transact in fiat backed by ‘thin air’ or a gold note what would you have more confidence in?

Not just confidence generally but that the note would retain its value. If something retains value and is known to be quality, people use it more and it functions better.

Trust is the currency of this game.

Jeff Probst Survivor

Similarly economics is a social science and experiment. You can not legislate trust it has to be earned. Econometricians forget that individual social aspect of economics is the micro-foundations for macroeconomics.

To attract deposits banks tried hard to establish credibility and trust. Think about your visa or master card. You feel confident that your card will stand by you if there is fraudulent activity. Or Amazon, it does out of its way to establish credibility. Google with search, puts trust at their priority, that the integrity of the results is optimized for user satisfaction.

Similarly, banks under free banking did everything they could to establish and keep their reputation.

Again think of your visa card and all the relationships this company has and agreements of trust. Similarly, banks made agreements so make sure people trusted the value of their currency. This was all before Google reviews and the nearly instantaneous transmission of information.

Therefore, banks became interchangeable much like visa cards today. Retailers will accept visa cards from Bank of America or your credit union as there is backing or trust and the profit motive. Banks could not hold inadequate reserves or take on risky strategies or risk-averse investors would quickly lose confidence in the currency. Therefore, this was not done historically.

  • Without this risky behavior, there would be no need for bailouts.

A government issuer can devalue and manipulate the vale of its currency for political ends or a deemed social engineering objective. Free banking could not do that or it would lose trust.

Example of the Federal Reserve’s performance

  • 1 US dollar in 1787 was worth $1.06.
  • In 1913 the Federal Reserve Bank was established and $1 dollar in 1913 is today worth .04 cents.

How can you argue with that? Not to mention something called the Great Depression.

Think of anything you buy. If you buy something of lower quality, that falls apart people do not want to continue to buy it or it does not function as it is supposed to well. I would rather buy and use something of quality. So it is with money. You want to hold and use the money of quality. People today do not have a choice the government stronghold on the money supply.

It is like under communism you had to buy your goods from the one state-owned store. In our society, it is all people know, so like under communism people have been economically conditioned to believe this is the reality. It took a generation in the post-communist countries to change their mentality.

  • The issue here is people do not have a choice in these most important commodity in the market.

The Federal Reserve has a monopoly on money. With any monopoly, the price is generally distorted. Even if the monopoly is well-intentioned and benevolent.

Money is no exception that the free market results in the most efficient outcome based on individual choices. This is in contrast to the Central Banks around the world printing money out of thin air to pay the governments spending and promises. Look at our debt today.

The Theoretical support for Free Banking

Resources on the Free Banking debate versus Central Bank

This is academic theory, not some battle cry to abolish the Fed. Respected non-conspiracy theorists advocate the return to free banking and sound money.

The following is an outline of the basic logic.

Definitions of concepts in monetary economics

Prices are inter-temporal information points. That is they coordinated demanders and suppliers of a good while also are considering the future. How much they want to consume of that good in time weighing all the possibilities now and in the future.

The information is about the supplier willingness to supply and demanders willingness to hold or use.

This coordination is done at a microeconomics individual level. For example, each person decided for themselves how much of that particular good they want to consume. Each person has a different utility preference to consume, for example, ice cream. However, in aggregate we can derive a demand curve.

Money is a commodity, which functions as a medium of exchange, store of value and a unit of account. It is the second half of every transaction. You barter something for money in every transaction.

Credit is a derivative of money and in a modern economy functions as the medium for purchasing power, what Mises called fiduciary media. Purchasing power is what expands and contracts and influences economic decisions.

Interest is the price of credit. That is an inter-temporal information point that tells us how much credit people want to consume now based on a future looking time horizon. This purchasing power can be for consumer or capital goods.

Capital are tools which enhance the production process. The wise use of capital will result in greater profitability. Entrepreneurs perform economic calculations based on market estimates and based their capital deepening on these economic calculations.

Therefore, if the price of money/credit is wrongly estimated by a central bank, even a smidgeon, it will cause market distortion. Especially in the capital markets where entrepreneurs are formulating long term plans.

This theory has roots with Carl Menger’s organic understanding of money, in the Knut Wicksell with a cumulative process of price movements and Ludwig Von Mises and Friedrich Hayek with distortions in the capital structure that cause a business cycle.

What do we mean by the wrong price of credit?

We mean specifically the interest rate, that is the rate controlled by the central bank for practical purpose the Fed funds rate does not coordinate the ex-ante investors and savers. I=S ex-post by definition. We are concerned with the ex-ante process of coordination. This forward-looking process that all humans have because of inflated frontal lobes.

If this price on credit is wrongly estimated we have a market distortion, much like rent controls or the government setting the price of gas at the pump. If there is too little of a supplied good, then there are shortages. There could be non-price rationing, like lines at the pump, and loss of consumer surplus. Similar and excess supply of good causes of waste in that market.

However, since money is the second half of every transaction, the way money works out its disequilibrium, is not in an individual market but in every market. Every market is a market for money.

Therefore, if the Federal Reserve sets the Interest rate too high or too low, the price of credit, then there is a severe issue that affects every individual.

In contrast, in free banking, the market sets the price of credit. In fact, for different risk profiles and lengths of the loans and asset compositions, there should be multiple rates of interest not just one rate of interest. The idea of one rate is that entrepreneurs will arbitrate all markets to this singular rate. In the Hayek Staffa debates on the 20th century, this point was brought out.

How does the Central Bank set the price of money?

The Central Bank uses a wholly empirically derived estimate called R-star, a proxy for the theoretical concept of the natural rate of interest. It is an economic estimate of the price of money that would bring money neutrality to all markets.

The historical evidence is the Federal Reserve has failed to do its job.

It is beyond the scope of this discussion to explain the econometric reasons why, but historically the based on the Great Depression to the Crisis of ’08 the central bank has not done a good job.

What about Free banking or even its cousin the Gold standard?

Prices were stable and the US reached its gilded age. This was in a time of great historical upheaval and the industrial revolution and when the information was arguably less perfect than it is today.

The historical date of growth, stability and the Gini coefficient argues the Federal Reserve has not done as good of a job as free banking or the classic gold standard.

Why do we have a Central Bank? The political reason, so we can finance endless overseas military acts (these are not wars as Congress did not declare war) which we do not win or other programs. Who pays for it? The working and middle class. Who benefits, the people who have access to credit and work on Wall Street. The fat cats on Wall Street have they earned their money in the same way as hard working entrepreneurs? The irony is this is not Marxist speak, rather, free-market ideas.

Could we eliminate the Federal Reserve and return to free banking? Yes if there the paradigm is overturned. Paradigms are overturned all the time. It would translate for the US a return to the free market and free choice.

Real Estate

How to Build a Cheap Home – An Economist’s Recommendation

I am a real estate agent and an Economist. I also am a do it yourself/quasi homesteader. That being said since I have been a real estate agent for years and a cheapskate all my life, I have observed how others construct a home cost efficiently. I have lived in different parts of the world I have observed how people build their homes.

You can have it all for less than $20,000 in the United States of America. You can live in a tiny home for less, but I am talking about a nice home, that you and your family can live in and feel comfortable.

Build an inexpensive home and save money

A nice small home

Tax deed, not auction

Buy land on tax deed. Buying land on tax deed is not the same as tax auction, buying on auction or tax liens. Buying on tax deeds means buying land after the county has tried to auction it and they can not sell it. You can find these on any county website.

I personally know farmers in my area who have bought land for $100 dollars an acre. They put a few dairy cows on their land and they make more than you do at your office job working 48 to 50 weeks out of the year. I am not saying that to be rude, I am not a rude person, just to make you aware and I wish people made me aware long ago. I had to find it out the hard way.

Buying land that is in growing or popular area is not possible. Expectations drive up prices. People watch too much HGTV and want it all for a bargain. For example, in my popular beach town, real estate prospects want a few acres on the beach to ride horses. Maybe in the 1820s but not today. Set your expectations on a homestead that is fairy-tale like, not hype.

Large homes waste capital, resources and need constant cleaning. This is an old fashion idea, to have a ostentatious house. For what? To impress people, to flex?

Read my post here – buying a big home is a waste. If you have a big home I would sell it and consider all the alternative economic and life opportunities there are with the free capital generated from the sale.

You need to buy land in a remote place nobody wants to go or be. Then you can buy cheap land. If you write to me I can recommend some places. I can recommend states and areas and no flood zone regions.

These will be cookie cutter homes and the developer will have a nice profit and you will pay an HOA and have no freedom.
Being poor can make you rich if you use your brain

Zone A not R

I recommend an agriculture area. You will have the freedom to do what you want. You do not want an agriculture area next to a large farm as the pesticides and herbicides are airborne and will affect your health. You just want some backwater place.

These homes have no space and you will pay a lot for them. I would not buy a home here. Yes they are spacious, but there is no freedom and you pay a mortgage all your working life. You will be thinking about your neighbors. I really do not want to do that.

County Taxes and regulations

Most rural areas have less restrictive building codes, but you want to make sure. You want to check with the country. For example, my county requires an $11,400 dollar impact fee to put a shove in the dirt.

  • You want a $50 dollar to permit not a $10k building permit.

If I were ever homeless

My goodness I would just beg for a few thousand on the street and buy a piece of land and start from there. Colonists homesteaded for hundreds of years and they built a great country. I see so many homeless people living their cars. I understand for multiple reasons, but I would just buy a saw and start to build.

What about location and culture

The whole world has a culture. For example, in Alabama, once the state where sitcoms joked about, as My Cousin Vinny, it now has high tech regions, a branch of the US Chess Federation, and the Mises institute centered there.

My point is the world has grown up and people are educated and there is something to do everywhere. I teach college and it almost seems the smarter students come from the countryside, and the city slickers just know about cell phones.

You also have the Internet and Amazon to buy anything anytime you want. So do not worry about culture or consumer deprivation. Your mission is to have a place to live that you do not work your life away.

Think of the movie Chitty Chitty Bang Bang, you want a good life not a showy life.

Location is the most important

I would say the Southern US is easier because the winters are less serve and you do not need heating. You also do not have Lyme disease. You need to think like a homesteader even if you are not. You can grow more seasons out of the year, so your garden can provide most of your food.

A garden saves money

If you can find a nice plot of land say, five acres you can call your own for a few thousand at most, perhaps a few hundred, you will be all set. Here is my post on gardening to save money.

  • You can get a logging company to clear it for free and they sell the lumber.

Ironically from tree companies, you can request free wooEconomistd chip and this will mulch what will be your future garden as the decomposition of wood chip turns into rich soil no matter what the initial soil status is.

Simple deer fence from local bamboo and will grow grapes on it, it will look nice. To buy 500 feet of fence would cost thousands of dollars. This was free.

New technology for your home construction

You do not have to worry about the grid, because new technologies circumvent this.

  • For building materials consider aircrete.

For building material, I would use aircrete as the price is about $8 a square foot to construct with. This could be your base and obviously, you add more around it later. But if you use aircrete for your construction, and you build this yourself, your cost is a fraction.

I was initially thinking hempcrete but aircrete is cheaper. It is concrete with a compressor and water and soap. If you mix seashells into the concrete it will make the strucure stronger. This is the basis of coquina. Coquina in my town of Saint Augustine is standing strong after 500 years.

The ancient Roman’s used coquina. If you can mix shells and concrete and the right combination of mortar air use a compressor for air. You will have light strong bricks that will last. Research coquina and aircrete.

Six homes and no job

You can look into other types of construction material. Cordwood homes are another alternative, but cost more. This guy as six homes paid in cash and never really had a job, I think. When making economic decisions think about all costs including opportunity cost of building a home. I do not know any top executives who worked their lives away who own six homes in cash.


Use Pex. You can start with a manifold and do a home run on each connection. Pex will last and the total cost will be less than $400 dollars depending on the size of your home. Pex you can do yourself. You can run it through the roof and drop it down the wall. If you ever need to replace it, all is visible and you will not be digging through concrete. You also have total control over every connection to shut them off if you need to. I would add a water filter at the end for your drinking water.

If possible I would dig my own well. You can rent a machine or do it with a shovel depending on how deep your water table is. I started with a shovel here with my garden well. If you want to go deeper there are techniques with compressed air.W

Water heater

  • Day 1 Hot water is overrated, you can use a cast iron stove/heater.
  • Day 2 Tankless or solar.


Day 1 You can use an outhouse. You can roll your eyes but be mature. This was used for most of human history.

Day 2 Think Roman arches. You can bury the plastic tank and then have a drainage field with arches like an infiltrator system. You can dig this with a shovel.


The price of solar has come down so much. Consider this. However, there are many new alternative ways to get energy. For the actual wiring, that is one place you might need help as I have only done a little electrical work.

  • Build that cheap house

You get the idea. The point is you do not have to spend, a half million for a house. You can build most yourself. People in Poland where my family is from almost all build their own house and have it paid off before they are 30 years old. Can you image that?

What is the point of working so much if all you are doing is paying off a life debt called a mortgage?

Mark Biernat

What will you do with your savings?

With all the money you save, just bank it. Create a stash of money and invest in your own businesses. My friends that work in NYC in professional environments have a sad life. They work all day and live for a few weeks vacation. Better is to be human. Live life and let your creative talents shine doing things that are out of the box.

Also, there is great satisfaction in knowing everything is new and works and you are not fixing other people’s problems.

So if you are thinking of buying a cheap home, maybe better is to build one. You can live in a temporary structure while you build it. To an American, it might sound alternative at best or hippie-ish. But much in much of the world, this is normal.

You can build a home for less than $1,500. But for nuder $25,000 you can live in the lap of luxary.

Another Economic Crisis

There will be another server economic crisis. I do not know when. However, the debt bubble can not last and an over extension of credit is causing malinvestment in the capital structure. Therefore, start thinking in terms of your economic future now.

If there is another financial crisis then you will be well positioned to purchase homes and property cheaper or stocks or just ride it out.

Remember, the grasshopper and the ant in Aesop fables. You want to be sober and industrious for yourself and your family. Even if others around you are do not see the metaphorical winter coming.

You can have a magical life with your family and more than you ever dreamed, as long as you learn to make wise economic choices. Investment should be based on real savings not an extension of credit. Remember the I=S equation in economics, make this real and if it is, you will be fine in any economic crisis.

Even if you do not build your own house, start thinking in terms of frugality and prudence. Think in terms of economic virtues. Ultimately living a good economic life is synonymous with understanding economic virtues.

I can recommend you read about the ideas behind the Austrian economic school of thought or simply how Americans when they built this country did it with little more than rugged individualism.

Inexpensive homes can be nice like Thomas Kinkade.

Why not leverage the best of both worlds and have the convenience of obtaining tools and capital goods to construct the home within the US and the concept of how other people do it with alternative methods in the rest of the world or other times in history in the USA. This is how you build a cheap home. Write me if you have questions as I have experience in real estate and economics.


David Ricardo On the Principles of Political Economy and Taxation in PDF

On the Principles of Political Economy and Taxation by David Ricardo was written in 1817. The Economic themes in this book were value and free trade. The book also addresses many subsidiary issues.

You can download it here:

On the Principles of Political Economy and Taxation by David Ricardo in PDF

I recommend you download it above, over reading someone else’s summary. Even reading a chapter or two of Ricardo’s book will give you greater insight, and puts you on better footing to understand the pros and cons of free trade or the idea of the comparative advantage than any general description.

From Mercantilism to Free Trade

  • Ricardo, like Adam Smith, believed free trade would overcome many of the issues connected with Mercantilist economics.

In the post Napoleonic era, England switched from mercantilism to free trade, or a closer semblance of free markets and a free movement of labor and capital, it reached its gilded age.

Although still an empire, under the influence of classical economic thinking such as Adam Smith or David Ricardo, England flourished while empires like Spain waned, and it was no coincidence.

The idea of mercantilism was to accumulate bullion by an export driven economy.

Mercantilism metaphor

Metaphorically mercantilism which saw countries economies as two tubs of baths, one hot and one cold, and when free trade is introduced or accelerated the hotter tub loses thermal energy and the cooler tub gains. For example, when the US trades with China, the US wealth or at least wealth creation is cooled off and Chinese wealth creation heats up or accelerates. Ricardo disagreed. These arguments initially seem counter intuitive until you understand economics and consumer and producer surplus gains from a comparative advantage.

  • Ricardian ideas on comparative advantage and free trade was the greatest contribution to economics found in On the Principles of Political Economy and Taxation.

Ricardo answers the above objection, that free trade is one sided, by use of logic and examples relevant to this 19th century world. His theory was based on specialization and a nation would concentrate on production and of resources that each country could generate wealth in an optimal way in comparison to other nations.

Any reallocation of the production process would be offset by efficiency gains. Ricardo used examples of Portugal producing cloth and wine at a lower cost than England but both England and Portugal would net out ahead.

Criticisms of Comparative Advantage Theory

Although his theory does contain weaknesses, he was aware of, his theory showed the benefits of free trade vastly outweighed the costs. For example, there were situations when capital was mobile as opposed to fixed and this would have different consequences.

Subsequent critiques included Keynesian Joan Robinson’s note that Portugal stayed underdeveloped in comparison to England. That is real world situations with dynamic equilibrium and less than full employment and with trade imbalances Ricardo’s theory of did not prove out.

However, in the end free trade would be a optimal. Specifically a country does not even have to have an absolute advantage to gain a comparative advantage. These terms Ricardo did not even use, but were coined and popularized by those like Johns Stuart Mill.

I (Mark Biernat) suggest if you couple Ricardo’s trade theory with free banking, that is an unregulated currency or sound money, trade imbalances can not sustain themselves. They have a self correcting mechanism. Free trade policy needs to be paired with a free money policy.

Ricardo in Modern Economic Terms

If Florida grows sugar cane and makes molasses and Connecticut grows apples and makes apple cider, it benefits both states to have no restriction on interstate trade. It would not make economic sense for Connecticut to become a vertically integrated molasses producer.

States are little different then countries. Free trade between regions or even towns and or households is similar free trade between countries. In the Middle Ages medieval faires and markets between towns ushered a new prosperity.

For example, if the soil and conditions and the expertise to create cheese and grow grapes in France is established, and India is better suited to grow cotton and send this to Vietnam to create clothes which are designed in the US. Why not allow this free economic process to unfold.

The net result is consumers get lower prices and it takes less cost to produce a comparable good. Society can employ resources that were used in less efficient production processes and allocated them in a different way.

Metaphorically when the PC was popularized if would have been inefficient to employ a legion of typists to do what a word processor could do. Those typist or the next generation could work in medical research and do higher level tasks.

Similarly, if India now grows cotton cheaper than the State of Georgia, people in Georgia can be employed in another field of work such as accounting or IT. Economics is dynamic and this will change every decade. However, the world is becoming more efficient with free trade and the most obvious consequence is general price stability and relative price deflation.

Theories are obvious after it has been stated.

Ricardo’s Theory of Value

Other topics in the book included a discussion on rent, wages and profit, and the labor theory of value.

The value of an object was based on the value of labor put into the creation of an object.

The value of a commodity, or the quantity of any other commodity for which it will exchange, depends on the relative quantity of labour which is necessary for its production, and not on the greater or less compensation which is paid for that .

David Ricardo

In the preface, you can read Ricardo’s critique of, Adam Smith, Jean-Baptiste Say, Turgot, Stuart, Sismondi.

Ricardo felt Adam’s Smith theory of value lacked conceptual rigorous. He refined it to a labor theory of value, something Marx would use as his core theory of value. It was not until the marginal revolution with Jevons, Carl Menger and Léon Walras was value uncoupled with labor directly. However, many people conceptually still hold to a Ricardian theory of value.

Ricardo noted that as population increased rents, because land was scarce and fix, would increase. He had made his money in the stock market but was concerned about the welfare of others. He believed free trade would help alleviate this issue as it would increase the wealth of both countries involved.

Ricardo and the AI revolution – On Machinery

Ricardo foresaw technology improving the production process but at least in the short-term it created issues with labor and wages. More important he saw mechanization, increasing the Gini coefficient. That is the capitalist would benefit from the new technology and this would decrease the cost of production. While workers wages would decrease as competition included new machines as well as labor as an input in production.

This is the situation we have today. Increased competition with machines and vector learning lowers the wages of workers. I know many people college educated people who are thrilled with a $15/hr job.

The reason Ricardo’s mind was so great as a classical economist is his idea are relevant in today political economic discussion. However, his ideas are not only applicable, they are foreshadowing. If you read his work from the original context you can gain insights into the future of our global economies today.

If you have question about the free trade debate, tariffs and how David Ricardo would respond if he were living today, please leave a comment or write me. These are important issues in economics and misconceptions can affect people’s lives.


If You Want to Make Money in a Capitalist Economy be a Capitalist

‘If you want to make money be a capitalist’. It is that simple. My father told me that and he will be 92 this year and remembers The Great Depression and his parents fled communist and feudalism. He has some wisdom. I am getting a PhD in economics. I will give you specific examples of what I see.

Capitalism by definition is involves being an owner of a creation process.

If you are in another economic system you need to be something else, for example under socialism perhaps a better strategy would be working for a government agency and move up the ranks through longevity with the organization and merit and politics. If you were in a feudal system better would be to rub elbows with the feudal lords and aristocracy.

However, as long as we have the system of capitalism, good or bad, you need to sit on top of a process. You need to take ownership in something. If you are a worker the capitalist will always pay your market value based on perceived value for the process. With issues like mass migration of people and the AI revolution this becomes challenging. In fact I would say working in corporate America is not an optimal situation. However, the entrepreneur takes risks and brings ideas into action. This results in profit.

This is not a debate of Adam Smith versus Karl Marx. We can leave the gloves at the door. While we are all saving the world by creating a utopia society we envision, lets also having some spending money in our pocket. Here is how in a market based economy.

After School program that makes 40k a month

A friend of mine was unemployed. He got fired from his last job. He started an ‘after school program’ for the elementary school system in my county. It took him two years to have 400 students. He charges $90 a month. He has some additional income so he earns 40k a month in gross revenue. His expenses are about 10k a month. For teaching in after-school 1 hour a night and employing a few extra teachers he nets 30k a month. That is, $360,000 a year. In the summer he does summer camps. After all taxes and expenses it is over 1/4 a million a year. I know this because I work for him. I just got back from working for him moments ago.

CEOs and Presidents of small companies do not make that. He does it by teaching elementary kids an hour in the evening Monday through Friday. Do you know how hard you have to work to do that? How many years in the corporate world would equal what he makes in one year.

He said he could expand but he has a house on the beach and everything he wants. It is all about fun.

Other ideas to make money

Most of the people I know that are making millions started something because they were fired from their job and living in the parent’s basement.

  • I know a lawn care guy that makes 200k
  • I know an HVAC guy that makes 200k
  • I know a website owner that makes 3. I know this for a fact, as I use to work with him. He makes 3 million Euro a year with his site.
  • I know another broke person that nine months latter makes 20k a month on his website. His friend makes 250k a month.
  • I know a YouTube person that makes 1.2 million a year.
  • I know a DJ that clears a few hundred thousand.
  • A friend of mine creates custom guestbook and makes a very respectable amount, more than her husband at a corporate job.
  • A few backyard farmers I know make 100k in their backyard.
  • I know a person who was so poor all they could eat is popcorn and cheese so they started a popcorn and potato chip company worth a few hundred million dollars.
  • I think my brother is worth about 100 million. He did it overnight with his own company.

I know these people personally or as acquaintances and have verification that they make this.

What about being a professional?

I do not know? What do you mean, like what, being a lawyer? That is so boring. The AI revolution creates the contracts, and the proliferation of law schools make lawyers and many other professions just another cube job.

Do you know see my point? Own a process. Think of something because by definition our system is based on property rights and ownership.

What kinds of Capital are there?

Capital is a tool or something used in the production or creation process. It is not money. You do not need money to make money. What you need is imagination. I tell my students better than memorizing is play and day dream. Forget test scores. Play and spend your day in your imagination.

  • Physical capital – Nice if you have it, but not needed.
  • Financial capital – great if you have it, but not required.
  • Intellectual capital – The highest level, this is brains, imagination, handwork intellectually. This will pay you the most. Think Apple, Google, Facebook, Microsoft, Harry Potter, How to train your Dragon, Taylor Swift (is she still relevant?) These mostly involves pen and paper or some idea. But you can shot lower and fly beneath the radar. It will give you a better life, like the examples I listed above.

Thinking is the hardest work there is, that is why so few people do it.

Why do I not do it? I do. I am working on programs. I have this website, I am getting a PhD in Economics as it would be easier to market a book with a degree, if I so desired. But you have to own something. The best capital is your grey matter is worth more than all the money in the world. You just need to brainstorms ideas and not give up.

I play chess and 40% of my wins are when I think I will lose, but do not give up. I do not want to pump you up and then leave you frustrated, as I am not a life coach or a motivational huckster I mean speaker. I just want you to make the connection between, play and capitalism. Play is not recreation, strictly speaking. Imagination and capitalism.

OK what about t-shirts and affiliates? I do not recommend selling affiliates etc. These are not your creations. You are only working for others. They are not imaginative.

Create something yourself. Be patient with yourself. Try to ask yourself what you like to image or play when you were a child. That is a good start. If it takes years, let it take years. I mean it, it often takes years and many ideas before something clicks. Focus on what you really love. Do not watch how to make money videos on ‘how to make money online’ as those people are not using their brains, just recycling ideas. Trust me I have had websites for fifteen years.

Make Adam Smith and Karl Marx both be proud as they were both classical economists who had a labor theory of value. That is real value is created in work. In this case, the work under capitalism is creativity.

If you want to know more about the economic theory that supports this read a book by Robert P. Murphy, PhD School economist. It Choice. That will inspire you more than any make money online books.

I am getting a PhD in economics and writing myself so I think I have some credibility and do not need to flex. If you have questions or ideas you want to bounce off me you can write me. I can give you some hints on how to bring this to fruition. I will not take your ideas as I have my own ideas I am trying to bring to completion and I am more an intellect than a cigar and port style capitalist.


Michael Woodford – Financial Intermediation and Macroeconomic Analysis – Review

Michael Woodford’s 2010 paper “Financial Intermediation and Macroeconomic Analysis”, improves his theory that was articulated in this book, Interest Prices (2003). He based this on the data and experiences from the 2008 financial crisis and changing ideas in monetary economics since his 2003 work.

I have academic respect for Michael Woodford, this review is in no way a commentary on Woodford himself, the sincerity of his efforts, or his intelligent progress he has made with macro economic science.

However, his theories have issues. Yes, at a tactical mathematical level, everything balances and the numbers correspond to his constructs. However, at the strategic level, I question the the constructs and the logic of his assumptions.

You can view Woodford’s paper here in PDF:

Financial Intermediation and Macroeconomic Analysis

Issues with Woodford’s Theory

His work on Financial Intermediation and Macroeconomic Analysis is correct in the sense we need to account for frictions and spreads when looking at the non-bank financing. I would agree with this underlying premise and the data.

Monetary policy based on questionable assumptions – My main criticism is that he advocate of micro engineering monetary policy by the Federal Reserve based on ideas that are not on sound theoretical footing. He advocates perfecting this through econometric models. .

My contention is even if AI were used to perfect the models and account for all variables it would still not get us closer to understanding human action in the market better than the entrepreneurial discovery process.

I think, his rule based approach is superior to discretionary action, but it does not necessarily lead to a high growth long-term equilibrium or optimal capital structure. This is particularly true when Woodford’s approach is coupled with quantitative easing and other tools of the Federal Reserve, outside the rule-based natural rate framework.

Specifically I have issues with:

  • His understanding of Wicksell’s natural rate of interest
  • Straffa’s critique of multiple rates of interest
  • Price stability being synonymous with Money macro equilibrium
  • His understanding of equilibrium and money neutrality
  • Central Bank rule based (Taylor) action as an optimal equilibrium course

These objections have not been addressed in his 2003 work. Therefore, to add another layer onto this with improve model’s I find it unproductive. However, I will give a summary review below.

What Woodford achieves in his paper on Financial Intermediation

He refines some of the ideas of the equilibrium rate of interest in line with an IS-MP and IS-LM model and adheres to the new Phillips curve, introduces multiple rates of interest, (not in the Straffa) and financial intermediation friction.

This kind of model provides a straight forward account of the way in which a central bank’s interest-rate policy affects the level of economic activity and also the inflation rate, once one adjoins a Phillips curve to the model).

Woodford, “Financial Intermediation and Macroeconomic Analysis”, 2010

Highly aggregated models do not represent human action

However, the assumptions of this model still are in question. The equations workout on a theoretical level, for example, merely altering the slope of the curves, and the precision of the model’s equations are refined. However, this is all on an abstract theoretical level and when markets are in a dynamic and changing environment, data from the past can not necessarily create predictable outcomes for future policy.

Regarding, individual intention and action and future outcomes, economists are notoriously poor prognosticators. If this is the case, policy should not assume so much power.

To bridge this Neo-Keynesian construct to the real world of diverse markets and all the effects and complex human interactions which are seen and unseen are hard to quantify and prove. The theory works in an equation, but in the context of this theory supports an optimal policy decision for long term high growth and real market prices, at the aggregate level it is hard to make a determination.

This ultimately stems from a misunderstanding of what money is and how it functions in real-world markets. This goes beyond improved models for representing financial markets with fiction or without friction.

IS-LM and the Phillips Curve

Further, ideas such as the Phillips curve and the IS-LM model are precise on the theoretical level, but they are just one conceptual framework which is based on a construct for current central bank fiat money. There are criticism’s of both models, for example, criticisms of the IS-LM, however, this is beyond the scope of this post. IS=LM is a diagram for intermediate economics to understand, but to take this into serious theory, the objections and there are many from Gregory Mankiw, mild criticisms to Austrian school major criticisms.

Why banking is important

Firm and entrepreneurial capital financing for the expansion of business come from three sources, retained earnings, bank financing and firms going directly to the market. Retained earnings being the largest component. However, economic analysis and a theory of interest rates is focused on direct and indirect financing because these sources are considered on the margin. Economic decisions are made on the margin.

From these three sources, Woodford focuses on direct external financing over indirect financing, and his most current rendition with the inclusion of friction.

Monetary theory with no banks – However, I question the subsidiary role he places on banking. This seems to support his 2003 work. He claims to revisit Wicksellian theory, but private banks is not a center of his model, only the central bank and direct financial markets. I would have to see more data and evidence to convince me that decisions made at the margin in the credit market are made by non-bank financing. This is a broad stroke of the brush to assert that. Does this apply to all markets and all scales of banking and relevant investment activity or just the activity he looked at or what is good for Central bank policy as it exists today? Does this theory support the current paradigm? What is the US did not bailout the banks and the Federal Reserve did not pump money the way it did, perhaps the banking system would have reorganized into smaller, more efficient banks (Richard Werner’s bank prescriptions), that would support a more positive Gini coefficient. Woodford’s theory is specific to a line of thinking in our current political reality not a universal economic theory of financial markets.

Woodford’s argument is his emphasis is on direct market financing because the growing total dollar usage of direct financing compared to bank financing in the and its perceived role in the 2008 crisis. Therefore his model is constructed with this bias. However, this is not logically rigorous.

Consider how retained earnings is disproportionately large compared to all aspects of external financing, direct and indirect. However, economic focus is largely on external financing. This is because a basic assumption of economics since the marginal revolution as people make decisions on the margin.

That is, what exerts the most influence over markets in terms of movement may or may not be the total dollar amount, but what has the most marginal effect as firms make decisions on the margin.

Woodford does reference studies on both sides but misses this fundamental point. That is before we focus on one construct such as direct financing, economics needs to validate if that is correct. Even if leverage is a factor.

This might be, but it also might be similar to retained earnings in a way which firms finance but the marginal or driving effect of banking and indirect financing should play an important role in the model

We can not assume that based on growth rates of total dollar amounts of funding that this particular method has the most marginal entrepreneurial or decision making an influence. It may be true or it may not be. I think further empirical study at a micro level would be required. What seems to have had the greatest influence can only be known when you see all the influences of human action, rather than raw aggregate data.

The market is continually changing. Indicators have different weights based on changing market conditions. Even if direct financing is growing in numbers, economists need to always weigh marginal analysis before an assumption is made.

This is analogous to any financial ratio used in stock market analysis. As times and economic conditions change in a dynamic economy different variables and ratios are better indicators than others. Before one can make an assumption of where the emphasis should be placed in a model careful study needs to be made particularly at a firm level to understand where the marginal decisions are being made.

However, Woodford concludes and starts the foundation of is model is reasonable.

“Hence, what is needed instead is a framework for macroeconomic analysis in which intermediation plays a crucial role; in which frictions that can impede an efficient supply of credit are allowed for; yet at the same time one which takes account of the fact that the U.S. financial sector is now largely market-based”.

Michael Woodford

Financial Intermediation as the center and important part of Interest Rate transmission

This crucial role of financial intermediation is acknowledged. However, where the weight and emphasis is place is what is questioned. How much explanatory value is placed on financial intermediation compared to a bank or non-bank indirect financing when you are looking at it from a marginal perspective.

Woodford argues a new theory:

“the most important marginal suppliers of credit are no longer commercial banks, and in which deposits subject to reserve requirements are no longer the most important marginal source of funding even for commercial banks”.

Bifurcation of Interest and the total cost of borrowing

Woodford builds a new theory of Financial intermediation in the context of IS-MP to include financial frictions.

However, at the core of this theory is an equilibrium interest rate where interests for savers and borrowers are bifurcated to represent friction.

The spread between the two rates can cause counter-intuitive results and affect Fed Fund targeting Policy. Specifically, rates can fall but the cost of borrowing can increase because of the spread increases. Conversely, the Fed funds rate could with the objective of restrictive policy, however, the increase and the cost of borrowing could fall because of the decrease in the spread. This was observed in the pre-crisis and crisis era.

For Woodford, it is the total cost of borrowing, that determines credit expansion. This total cost includes the borrowing rates but also the spread. When making analysis or policy one has to look at the picture to determine, if the supply of intermediation will tend to increase or decrease.

This bifurcation in an IS-MP model of financial intermediation helps give a more accurate model.

Like the Keynesian model of Wage and Price frictions, Woodford has a model of LD and LS frictions when considering the Fed Funds rate.

Financial shocks that are amplified

Woodford suggests a theory of amplified financial shocks of supply of intermediation ultimately affect aggregate demand.

Woodford states:

“The dependence of the supply of intermediation on the capital of intermediaries also introduces an important channel through which additional types of disturbances can affect aggregate activity…that shocks that might seem of only modest significance for the aggregate economy… can have substantial aggregate effects if the losses in question happen to be concentrated in highly leveraged intermediaries, who suffer significant reductions in their capital as a result. ” (p.19)

Woodford’s theory articulated is new in details, but overall the concept is not new. He goes onto describe the “vicious spiral… the resulting contraction of aggregate output may result in further losses to the banks, further reducing their capital, and hence tightening credit supply even more” (p.20).

Nothing more than mainline Keynesian idea dressed in aggregate equations

In one sense this is a rebranding of a Keynesian idea, this time supply of credit negative multiplier effect. Financial intermediation is an area that is leverage and have a disproportional effect on the market movement and in a cumulative fashion.

Like Richard Khan’s Keynesian consumption multiplier, Woodford transposes the known Keynesian ripple effect logic to the supply of intermediation.

To some extent, the supply of financial intermediation is analogous to a Keynesian wealth and income effect or some sort of multiplier.

Woodford writes:

An increase in aggregate economic activity will generally increase the value of intermediaries’ assets (loans are more likely to be repaid, land prices increase with increases in income, and so on) and hence their net worth. This will allow additional borrowing by the intermediaries, and hence a larger volume of credit for any given credit spread. (p,16)

The 2008 Credit Cycle

The Fed Funds rate did not act as a perfect tool or measure because of the spread but also another observed phenomenon.

That is shorter terms rates do not affect investor decisions as much as thought. Rather, ” level of long-term interest rates, which in turn depend on the expected average level of short rates over the coming decade, rather than the current level of short rates alone” (p.20)

This caused borrowing rates to fall with an increase in rates

Woodford understood the Wicksellian framework. He should have know before the 2008 crisis. His theories have empirical evidence, but as you see every crisis is different in a subtle way. It is not that a new exactness would bring the central bank closer to an optimal societal outcome not to mention, productive and allocative efficiency.

  • However, his theory does ex-post explain why rates were too low for too long after rate increases. As a Monday morning quarterback or an armchair historian his theory is excellent.

For example, from 2004 to 2007, though policy the Fed Funds rates increased. Yes Woodford makes a good point that frictions or spreads could to be accounted for to have a more accurate model. However, the underlying idea that the Fed Funds target was too low is still the main idea.

The inescapable issue

However, I continue to suggest, regardless of the new tactical improvements in modeling, the strategic picture is credit was too expansive for equilibrium let alone money macro equilibrium.

What if the natural rate was really 6% or 8% at that time? It would make no difference in the larger picture if frictions were not calculated. What would have mattered was the Fed Funds rate was brought up to a proper level to match the natural rate of interest net of all adjustments, which it was not. In retrospect, it was not even close.

In fact, in light of Woodford’s new theory we could call the Econometrically derived natural rate the ‘net natural rate’, if you consider frictions. The strategic picture is still the same. Either, the natural rate is not something that can remotely be measured in any context or model estimates were off and continue to be off.

Therefore, even if you enter in frictions, the larger framework might be some adjustment to the natural rate calculation, but still, my premise is, the Wicksellian natural rate was significantly underestimated.

Woodford’s rebuttal is explained in the context of his model.

“an outward shift of the supply of intermediation schedule XS was responsible, rather than a movement along this schedule in response to a loosening of monetary policy.” (p. 22)

Further, Woodford argues :
“the Fed’s increase in the funds rate over the period between 2004 and 2006 did less to restrain demand than would ordinarily have been expected”

Multiple interest rates

Woodford’s understanding of multiple interest rates is not based on the idea that each entrepreneur might have a specific natural or equilibrium rate, rather there are different rates between investors and savers. This would be a Straffa or even Robert Murphy understanding. Rather multiple rates of interest to Woodford is simply stratification of a singular conceptual policy rate to account for frictions.

“Suppose that instead of directly lending to ultimate borrowers themselves, savers fund intermediaries, who use these funds to lend to (or acquire financial claims on) the ultimate borrowers. Then it is necessary to distinguish between the interest rate
i s (the rate paid to savers) at which intermediaries can fund themselves and the interest rate
i b (the borrowing or loan rate) at which ultimate borrowers can finance additional
current expenditure.

Like the gambler who things they can game the system

Which is a key point, that modeling of aggregate values, no matter how precise based on the last crisis will not be the same for the next crisis. This is because entrepreneurial optimizers, profit maximizers will find the next avenue to exploit. These exploitable holes exist because of monetary excess resulting from a departure from free-market banking will create a crack in the structure, and not always in the same place.

The system is design for smart individuals to work around it and take advantage of it. However, the more convoluted it becomes the less just it also becomes. This is why perhaps the focus should be on sound money rather than perfecting the a system that can always be gamed by the next generation of smart profit maximizes.

It is not that economic science should not model, rather we need to a course correction. The models should be based on the acknowledge that the natural rate framework, as seen by econometric models of R-star is not a meaningful tool. To build a model on this will not temper future business cycles or result in a higher growth model, rather a misallocation of resources.

Woodford’s Model for future monetary policy

i) the current value of the “natural rate of interest” – the real interest rate required for output equal to the natural rate, in the absence of financial frictions – converted into an equivalent. One might alternatively define the natural rate as the real rate that would be required for output, nominal interest rate by adding the current expected inflation rate, and
(ii) the current interest-rate spread. (p.24-25)

Spread targeting

Woodford’s new policy suggestions include not just interest rate targeting but spread targeting. If policy rates are at zero bounds then Central banks could intervene in market by favoring “the extension of credit to intermediaries by the central bank, on easier terms than are available from private creditors.

…Such a policy can relax the constraint on the size of intermediary balance sheets resulting from limited capital in the intermediary sector, by allowing increased leverage. “(p.27)

I question if the continued path of more complex interventions into market mechanisms is the best policy for long term growth. When this type of policy is known, opportunity can arise where economic agents expect the policy act in a way that would either change the policy action or would not result in desired effects in aggregate or in an optimal free market outcome of allocative and productive efficiency.

Reducing spreads is, in essence, returning a profit margin for firms that are working to provide a market service. It is favoring one group over another for a policy outcome which is questionable in the context of optimal growth.

Woodford acknowledges that it is not a long term policy for central banks to hold non-liquid non-treasury assets, however, the justification being a welfare effect to society if the central bank deems the market is not providing enough credit.

Woodford concludes that until increased regulation and financial supervision is in place, to have the policy tool of spread reduction to enhance rate targeting is recommended.

Zero Bounds Policy

The policy of targeting spreads as a zero bounds policy brings into question if the central bank should have put themselves in a zero bounds situation in the first place.

If a central bank as exhausted its primary monetary tool by putting themselves in a zero bounds position, perhaps it is based on their political motives to jump-start the economy as fast as possible instead of what is good for the long run optimal. This includes not only inflation and output but true allocation based on value. I question if the adverse trend in the Gini coefficient is not correlated to the central bank mis-estimating a fundamental policy guide as the natural rate of interest and whether a rapid and persistent decline in rates to a zero bounds situation did not exacerbate that.

Therefore, a further theory of fine-tuning a policy which is questionable comes into play, better is to examine the natural rate and rate targeting policy.

That is the cost of borrowing increased simply because the natural rate in certain markets was still higher than the fed funds rate increase. Wicksell would maintain an increase or decrease the money rate of interest needs to be seen in the context of the natural rate.

Even if the intricacies of the money market model did play a significant role, it comes back to the point that, R-star an econometric proxy of the natural rate was not high enough to keep the inflation of asset prices in check.

That is an economy with fiat money at an aggregate level will not manifest money macro equilibrium with econometric estimates of the natural rate of interest, no matter how precise the model seem.

The next crisis will exhibit different subtle features and characteristics that will cause this macro disequilibrium to prove out. It is precisely because disequilibrium with rational and forward-looking decision makers that optimize behavior, that investors will circumnavigate counter active policy.

The underlying premise being if there is a disequilibrium in the market for money, it will manifest in a new way. You can suppress the symptoms, but the disequilibrating effects, whether it is seen in, entrepreneurial efforts being steered towards non-market optimal ventures, the Gini coefficient, or asset bubbles will be there will be a crack in the structure. It will result in productive and allocative inefficiency, even if the economy seems to be in equilibrium.

If it did not we would all be able to predict the next crisis and policymakers would be able to steer us clear.


Natural Rate of Interest- Wicksell – Price Stability

Price Stability equated with neutral money

Wicksell’s third definition of the natural rate of interest focused on the price level. That is there is a rate of interest that tends neither to increase or decrease prices. That is, when the observable market rate of interest is at a certain level, the price level will be stable and there will be no tendency for price inflation or deflation.

Wicksell writes:

“There is a certain rate of interest on loans which is neutral in respect to commodity prices and tends neither to raise nor lower them.” Wicksell, Interest and Prices, 1898. p.188

In this situation when the natural rate and market rate is equalized you would see stable aggregate prices. Working backward into the equation, when there is no inflation or deflation, we can say that the natural rate of interest is equal to the market rate of interest.

Relative Prices versus Absolute Prices

However, this says nothing about relative prices. Relative prices could change as a result of technical process.

“It is true that as a result of changes in the conditions of production, due for instance to technical progress, first on and then another group of commodities will be obtainable with a small expenditure of labour and other factors of production, and that must cause continual disturbances in relative values. But there is no apparent reason for any alteration in the general level of money prices.” Wicksell, Interest and Prices, 1898. p.193.

An important point here is, Wicksell’s definition of the natural rate referring to general price stability needs to be seen in context. It does not go into how interest rates can affect relative prices but keep the appearance of price stability. This is taken up by the Austrian business cycle theorists.

Why all definitions of the natural rate of interest matter

It is a consequence that flows from Wicksell’s other definitions of the natural rate being filled. That is, the marginal productivity of free mobile capital being equal to the market rate, hence the demand and supply of real capital being equal, therefore, as a result, prices in a static equilibrium tend neither to rise or fall.

In other words, there are a series of conditions before price stability is reached

  • †The MPC in natura = i(market)
  • Ex-ante I=S
  • Assuming static equilibrium.
  • No increase in general productivity from technical gains that would reduce the overall cost structure of production. For example the AI revolution or in the 1920s electrification and automation.

This last point is important because if you see price stability, it does not mean that the natural rate equals the market rate or that I=S ex-ante. It could be price changes from a change in productivity.

Prices metaphor to weight

This would be analogous to someone who works out, and the doctor says they are overweight because thet shows their weight as out of range. However, if this weight gain is muscle, from training this has decreased their fat percentage but increased total mass. Therefore, the doctor’s conclusions are incorrect. And his policy recommendation for the person to lose weight incorrect. In contrast with someone who is in the normal rate of numbers, but has skinny arms and a gut. You can not just base an equilibrium on observed data without understanding what is behind the data.

Therefore, this is the weakest of Wicksell’s definition of the natural rate of interest. Better is to focus on Wicksell’s understanding of the natural rate as the rate where the in marginal return on newly created free mobile capitl.†

Stable prices can not be considered equilibrium without a capital theory

Modern theorist miss this point. The Federal Reserves mandate of price stability and target of 2% is not only arbitrary but potentially damaging to the capital structure. In the Holston-Laubach-Williams (2017) model which estimates R-star, the modern version of the natural rate of interest, this line of thinking is not considered. It is a large theoretical oversight.

theory is largely replaced with a focus on prices in a monetary economy, rules targets. For example, Michael Woodford in his book Interest and Prices, 2003 takes Wicksell’s observable consequence of stability in Wicksell’s static equilibrium construct and applies it to a dynamic equilibrium virtually without reference to Wicksellian or Austrian capital theory. It is more about flexible prices and wages for Woodford. These have to be flexible, for the past, present, and future. Rigidities versus price flexibility is more important in his equilibrium rate than developing his theory along the lines of capital theory.