The natural rate of interest is zero.

Author:Forstater, Mathew

This paper argues that the natural, nominal, risk free rate of interest is zero under relevant contemporary institutional arrangements. However, as Spencer Pack reminded us, "[n]atural and nature are complex words, fraught with ambiguity and contradiction" (1995, 31). The sense in which we wish to employ the term natural here does not imply a "law of nature," which may be why "[Alfred] Marshall replaced the evocative label 'natural' with the more prosaic 'normal'" (Eatwell 1987, 598). Marshall may have clarified it the best when he wrote that "normal results are those which may be expected as the outcome of those tendencies which the context suggests" ([1920] 1966), 28, emphasis added). In this case, it is of the utmost importance to first clarify the context, to which we now turn.

State-Issued Currency

The primary, defining institutional arrangement characterizing the relevant context is that of a "tax-driven" state currency and flexible exchange rates. By state currency we mean to indicate there is a government that taxes and has a monopoly of issue. A flexible exchange rate is commonly referred to as a "fiat" currency, in other words, a state-issued currency convertible only into itself (Keynes 1930), as opposed to a fixed exchange rate policy such as a gold standard or other convertibility to any other commodity or currency fixed by the state of issue (such as currency boards, pegged currencies, or monetary unions). Examples of such monetary systems currently include the United States, Japan, and most of the world's industrial economies, including the Eurozone, although the individual nations are no longer issuers of their currency.

There is a long tradition of analysis of state currency, or "state money," referred to by Charles Goodhart as the "cartalist" (or chartalist) school of monetary thought and which he has contrasted with the "metallist" (Mengerian, monetarist) tradition (1998). While authors such as Joseph Schumpeter (1954) passed down a view of chartalism with a misplaced emphasis on "legal tender" laws, resulting in something of a "legal" or "contractual" version of chartalism, Goodhart has made clear that the fundamental insight is that the power of the state to impose a tax liability payable in its own currency is sufficient to create a demand for the currency and give it value. Recent research into the history of economic thought has revealed substantial evidence of past support for this thesis regarding tax-driven money: we now know that, throughout history, many more economists understood the workings of tax-driven money, and many if not most currencies in history were in fact tax-driven, contrary to what was previously thought to be the case (see, e.g., Wray 1998, 2004; Bell and Nell 2003; Forstater forthcoming).

The idea of a tax-driven currency was once common knowledge. It can be found in the writings of economists and others going back to Adam Smith and beyond. Smith well understood that taxation is the key to understanding the value of state money (in fact, he used the American colonies' issue of paper money as an example-see Smith [1776] 1937, 311-312). So did a diverse array of economists that came after him, including John Stuart Mill, William Stanley Jevons, Phillip H. Wicksteed, and John Maynard Keynes, among many others (see Forstater forthcoming).

A key distinction is that between the government as issuer of a currency and the nongovernment agents and sectors as users of a currency. Households, firms, state and local governments, and member nations of a monetary union are all currency users. A State with its own national currency is a currency issuer. The issuer of a national currency operates from a different perspective than a currency user. Operationally, government spending consists of crediting a member's bank account at the government's central bank or paying with actual cash. Therefore, unlike currency users, and counter to popular conception, the issuer of a currency is not revenue constrained when it spends. The only constraints are self-imposed (these include no-overdraft provisions, debt ceiling limitations, etc.). Note that if one pays taxes or buys government securities with actual cash, the government shreds it, clearly indicating operationally government has no use for revenue per se.

When the U.S. government makes payment by check in exchange for goods and services (including labor), or for any other purpose, the check is deposited in a bank account. When the check "clears," the Fed (i.e., government) credits the bank's account for the amount of the check. Operationally, "revenue" from taxing or borrowing is not involved in this process, nor does the government "lose" any ability to make future payments per se by this process. Conversely, when the U.S. government receives a check in payment for taxes, for example, it debits...

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