HOW EXACTLY DOES The Economy Return To Equilibrium?

Suppose the natural interest rate is negative. The amount of the real interest rate necessary for conserving to equivalent investment given a level of real income add up to the productive capacity of the economy is significantly less than zero. Suppose that the financial order is situated upon platinum Further. The dollar price of gold is fixed by definition. The nominal interest can be no more negative than the storage space cost of yellow metal. Potential lenders will simply hold onto the yellow metal than lend at any nominal interest rate lower than that rather. How does the economy go back to equilibrium?

Assuming the natural interest rate is below the near-zero nominal bound for the nominal interest, how can the true market interest rate change negative? Or will there be some market process that will improve the natural interest back up? Like the scenario where there are no precious metal standard and the true interest rate is negative, the shift from negative to produce property to gold, boosts the demand for gold.

The nominal and relative price of platinum rises enough to clear the market. With a gold standard, the relative price of silver can still rise. Further, it can rise to a point where it is expected to fall at a rate add up to the (negative) real interest. However, it is more standard to spell it out this as a reduction in the purchase price level to a spot so low that it is expected to rise again from that low level.

The rate of recovery in the price level implies expected inflation. This expected inflation reduces the true market interest. This process can make the true market interest sufficiently negative such that it keeps conserving and investment identical given a level of real output add up to the productive capacity of the economy.

Given this negative real interest, real consumption and real investment together add up to enough real expenditure to purchase everything companies can produce. This process requires that there is some expectation of a “normal” price level. The reduction in the current price level must be understood to be temporary, so the lower the price level falls, the faster or more prolonged the expectation of future inflation. One important characteristic of the precious metal standard consists of risk. Only in the special situation where “the” natural interest is negative and the price path of platinum is certain will the price tag on yellow metal immediately rise and then fall along that path at the natural interest rate.

The process by which the purchase price level falls to an even so that it is expected to rise again to some kind of long run equilibrium value of the purchase price level is short-term by its very character. If the natural interest rate is briefly negative, then this process creates a sufficiently negative real market interest to return to equilibrium. However, when there is even more persistent problem, where with expectations of real income and output constant with reality even, preferences and realistic investment opportunities result in a negative natural interest rate, this technique is more than a bit paradoxical.

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The price level must fall to a spot where it is likely to rise at a level add up to the negative natural interest forever? In other words, in secular stagnation scenarios, a razor-sharp deflation with the expectation that the purchase price level will ultimately rise back again to normal doesn’t really help.

Fortunately, there’s a second process at the job that escalates the natural interest. If there is no precious metal standard, and negative real interest rates to boost the demand for the yellow metal, the resulting upsurge in the price tag on gold results in capital gains for those already owning gold. This increase in wealth results within an increase in consumption, which is equivalent to a reduction in saving. The reduction in the supply of saving raises the natural interest. Using the natural interest rate below zero by assumption, it becomes less negative. At a price of platinum sufficiently, the natural interest rate rises above the storage cost of silver, and the economy come back to equilibrium.

With a precious metal standard, this is called the “Pigou impact.” At a lesser price level, the true value of platinum holdings rise. Gold being wealth, this is an increase in real wealth. As wealth goes up, consumption goes up as well. That is a reduction in the supply of keeping. The natural interest rate rises. At a low price level sufficiently, the natural interest rate will rise enough such that it is no longer lower than the price of storing gold. The true market interest fits the natural interest rate, saving equals investment, and real expenses equals the productive capacity of the economy.