Demand and Supply of Loan Capital Equal
Wicksell’s second definition of the natural rate of interest is the rate at which the demand for loan capital and the supply of loan capital is equal.
Wicksell writes “The rate of interest at which the demand for loan capital and the supply of savings exactly agree, and which more or less corresponds to the expected yield on the newly created capital, will then be the normal or natural real rate. (Wicksell Lectures on the Political Economy V2 Money (1935): p.193)
Wicksell’s second definition of the natural rate that equalizes the demand and supply for loan capital should be the same as the marginal productivity of this capital, that is his in natura (barter, term used by Mises) definition. He is not changing the definition but stating it from another angle.
Wicksell’s Capital Defined
The key here again is Wicksell’s definition of capital. Wicksell defines new loan capital, as mobile and not tied up in the production process. It is a very specific form of capital. It is not synonymous with common understandings of capital in terms of wealth or financial capital or simply any tool that enhances the production process, including fixed machines. Rather, Wicksell’s understanding goes back to the original meaning of capital from Adam Smith. Smith understood capital as ‘stock’ which in farm terms meant movable capital from a farm, hence the word livestock.
Wicksell writes: ” Of course, we are not here primarily concerned with capital which is more or less fixed or tied up in the production, such as building, ships, machinery, etc., for its yield has only an indirect influence on the interest rates in so far as it can attract or repel the employment of new capital in production. It is the latter mobile capital in its free and uninvested form with which we are concerned.”
Wicksell, Lectures on the Political Economy V2 Money, (1935): p.192
Not monetary or fixed capital
Wicksell discusses the production process and real physical capital, and not the price in money terms or credit at the bank for loanable funds. The supply and demand for capital meet in real, rather than monetary forms. Specifically, here Wicksell’s discussion again is concerning real mobile capital. This is congruent with his earlier writings that this is a non-monetary return on capital. To reiterate the point it is called the “natural” rate of interest rather than the monetary rate of interest, the loanable fund’s rate of interest.
Wicksell’s Theory did not Elaborate on Estimates
Nor is it an estimated rate of interest in a monetary economy. If Wicksell wanted to develop that theoretical line, that is an estimated rate in a monetary economy, he would have elaborated on this. Rather he specifically used the word ‘imaginary’ in reference to the natural rate and discusses at length the notion of capital being real and this means distant from any monetary influence.
If money were embedded in this equation it would change the whole theory. It would be a different theory, and would not link the real and monetary worlds in the same way, rather a distorted way.
Wicksell writes: “My thesis is, therefore, only an abstract statement, and somebody, perhaps, will ask: what is the use of it then? But I venture to assert that it may be of very great use all the same. Everybody knows the statement of Newton that, if the attraction of the sun were suddenly to cease, then the planets would leave their orbits in the tangential direction; this, too, of course, is only an abstract proposition” Economic Journal, XVII (1907), pp. 213–220.
It is a theory. A theory that describes an abstract theoretical concept, the “mechanics of price”, rather than a prescription for monetary policy to engineer the demand and supply for loan capital.
Wicksell does not go into how this should be determined or estimated or if it should be estimated, rather it is positive explanatory theory rather than normative policy assertions with welfare trade-offs.
These definitions of the natural rate of interest will be later taken up later by Mises in The Theory of Money and Credit in 1912, and Hayek’s Prices and Production in 1935. Keynes also explored this in Keynes’ A Treatise on Money in 1930.