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Neo-Wicksellian macroeconomics

Modern macro has more to do with Wicksell's Interest and Prices than with Keynes' General Theory. For one, the idea of a natural rate of unemployment derives directly from Wicksell's natural rate of interest, as Friedman noted. So here is a brief explanation of Wicksell's main argument in that book.

Wicksell distinguished between the natural rate of interest (R*) and the monetary or bank rate of interest (R). The former was determined by the marginal productivity of capital (I) and the intertemporal decisions of consumption (leading to savings S), along the lines of what became known as the loanable funds theory. The monetary rate was determined by bank decisions. That is, banks supplied credit (Ms) at the chosen rate of interest (R), according to money demand (Md). Monetary equilibrium occurred when the two rates coincided (see figure below). The natural rate is the gravitational center around which the bank rate fluctuates. Real and monetary shocks could cause deviations of the bank rate from equilibrium.

Wicksell assumes that a positive productivity shock raises the natural rate of interest, and that banks maintain the initial monetary rate. Thus, with a low bank rate, investment exceeds savings and once the system reaches full employment prices would go up. However, continuous lending would reduce bank reserves, and as a result banks would be forced to increase the monetary bank until a new equilibrium was reached. Inflation resulted from a bank rate that was too low, as much as deflation (and temporary unemployment) from a bank rate that was too high.
The low bank rate implies overinvestment, and the need for additional savings. The inflationary process by reducing the ability of consumers to spend provides the additional 'forced savings.' Inflation acts as a tax that provides the additional resources needed to finance investment. The business cycle can be explained by exogenous shocks to productivity (the I curve), changes in consumers preferences (shocks to S), or by the misconduct of the banking sector (shocks to Ms). Wicksell, as much as the modern Real Business Cycle (RBC) School, favored the former.


  1. Totally agree Matias. I also think that RBC is the only logical coherente neoclassical view nowadays. As Wicksell early recongnised, it´s impossible to explain the usual bussines cycles facts (rising prices with rising interest rates) with a conventional neoclassical demand shock story (falling interest rates with rising prices). So in neoclassical terms, RBC is the way to go.

  2. Not sure if I would agree that RBC is more coherent than any other approach. By the way, the so-called New Neoclassical Synthesis just puts RBC together with rigidities. I find all versions of the mainstream, which rest on a notion of a natural rate, pretty difficult to defend.

  3. Matias

    You might find this article by Nick Werle of interest - A Keynesian Epistemology of Statistics

    Classical political economy starts and ends with the liberal individual. In this story, when the rational homo economicus meets others of his ilk, his natural inclination to “truck, barter, and trade” compels him to engage in mutually beneficial exchange. Classical theory sees this moment as the organic birth of the market. Smith, Ricardo, et al. begin their theoretical work by analyzing how strictly rational agents navigate this exchange. This theory of individual decision-making bears the load of the entire classical edifice, which takes a market economy to be no more than the sum of these decentralized decisions. John Maynard Keynes, however, sees a fallacy of composition in this assumption. In his General Theory of Employment, Interest, and Money, Keynes argues that the economy as a whole has its own organic existence, irreducible to the individual agents making decisions within it. Thus, he inaugurates macroeconomics as the study of the whole economy, a discipline properly free from the classical microfoundations.

    Rather than analyzing the implications of rational choices and markets for individual goods, macroeconomics works on aggregate quantities such as employment, national income, and effective demand. Keynes demonstrates how these data have an organic dynamical interaction that does not supervene on any theory of individual decision-making. Furthermore, they reflect the overall health of the economy in which people actually live. Despite the fact that it is irreducible to the analysis of rational choice, macroeconomics does have a fully developed theory of the individual psychology. Indeed, the way Keynes’ General Theory describes decision-making is far more faithful to subjective experience than the idealized rational agent depicted in mathematical neoclassical theory. The Keynesian individual lives, works, and invests in a fundamentally uncertain world, and the nature of his expectations reflects that indeterminacy. In making predictions about the future, he relies on his recent experience, not double integrals. His decisions depend more on confidence than on rationality.

    This essay proposes a novel reading of Keynes’ General Theory

  4. The link to Werle's paper - "More than the Sum of its Parts - A Keynesian Epistemology of Statistics" published in in the Journal of Philosophical Economics is here

  5. I don't think that the proposition, from the abstract admittedly and as yet without a careful reading of the paper, is completely accurate. Classical political economists (in particular, Quesnay, Smith, Marx, but even Ricardo) were not utilitarian and paid little attention to individual behavior that was not constrained by social class. Subjective decision making was not central, and I would argue is also not central to the main positions in Keynes's General Theory. Thanks for the link to the paper.

  6. "Thus, with a low bank rate, investment exceeds savings"

    How does that work? I thought that in aggregate savings = investment ?

    1. Firms borrow at the monetary rate, and savings decisions too. So in the short run if the monetary or bank rate is lower than the natural one investment would exceed savings, as depicted in the graph.

    2. I think the key is that the graph is *DESIRED* S and I. *ACTUAL* S and I will be the same.

    3. Actually no. No need for any discussion of desired and actual I and S.

    4. Take closed economy with no g for simplicity. Y always = C + I. We define Y - C = S. So S = I. Actual S and I are always equal. So how do you reconcile that with your graph? I think the issue is that your graph is 'desired' S and I, not the actual accounting of what occurs.

    5. Here's a reference -

      Clearly you have to distinguish between actual and desired S/I. In accounting terms S and I are always equal once production has taken place. In your graph, it's possible to show S being different from I. Therefore, it must be desired S/I. This is why I think Philippe was confused.

    6. Clearly NOT. Once the I curve jumps (as a result of a productivity shock) you are at a disequilibrium position in the IS graph. The actual I and S are not equal, since I can be financed by the low banking or monetary rate. There is NO discussion of what agents desires are. These are irrelevant and not shown in any way in the graph above. The discussion of ex-ante and ex-post I and S, corresponds to the Swedish and then Keynes' later preoccupations with a system in which investment determines investment (above you have the opposite in a Say's Law world), and savings adjusted ex-post to investment. By the way, it is the sort of terrible confusion (the ex-ante, ex-post, desired and actual) that should be avoided. The logical multiplier is much simpler and coherently gets the idea that investment determines savings.

    7. If there is no discussion of agents' desires, then how did you graph the S and I curves? What are they functions of?

    8. Isn't the usual lingo that S = I is a true identity, thus always equal? I'm also confused.

    9. Matias: I think you are mistaken here. But I also think there is a way to re-state what you are saying so that it respects standard accounting conventions. And desires do matter.

      When individual firms borrow money from the bank, planning to spend that money, they do not know that every other firm is doing the same thing. So they are surprised to discover that all the money they spend returns to them in increased sales. So that, at the end of the "Stockholm period", each firm (or household) is surprised to discover that it holds more money than it had planned to hold.

    10. Hi guys. Sorry for the delay in replying. Functions are the actual Marginal Productivity of Capital for I and the intertemporal Consumption (Savings) Preferences for S. This is not a period analysis in which you check whether the Investment of Savings plans match and how they adjust if they don't.

    11. That is the standard approach in any intermediate macro text. Those are considered "desires."

      You're also not confronting the fact that you are claiming that actual aggregate S and I aren't equal. That's impossible under standard economics accounting. Either you're making a basic error, are using some alternative means of accounting, or aren't explaining what you mean clearly.

    12. Yes, in the case of savings (investment is hard cold productivity). Yet the point is that you do NOT need to check whether the desires were fulfilled or not. They are also the actual savings. The approach in which you deal with actual and planned (as in desired being different from actual), was based on period analysis. The standard approach uses what Keynes referred to as the logical approach (as in his logical multiplier).


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