Some economists have been arguing that the “equilibrium real interest rate” (that is the “natural interest rate” or the “originary interest rate”) has become negative, as a “secular stagnation” has allegedly caused a “savings glut.”1
The idea is that savings exceed investment, and that a negative real interest rate is required for bringing savings in line with investment. From the viewpoint of the Austrian school, the notion of a “negative equilibrium real interest rate” doesn’t make sense at all.2
To show this, let us develop the case step by step. To start with, one should make a distinction between two types of interest rates: There is the market interest rate, and there is the originary interest rate.
The market interest rate is the outcome of the supply of and demand for savings in the market place. It can be observed, for instance, in the deposit, bond, or loan market for different maturities and credit qualities.
The originary interest rate is a category of human action, saying that acting man values goods available at present more highly than goods available in the future. In other words: Future goods trade at a price discount relative to present goods. For instance, 1 US$ available today is preferred over 1 US$ available in one year’s time.
If 1 US$ to be received in one year’s time is valued at, say, 0.909 US$, the originary rate of interest is 10 percent. (1 US$ divided by 0.909 minus 1 gives you 0.10, or 10 percent, for that matter.) 10 percent is here the originary interest rate (disregarding any other premia).
The “Originary Interest Rate” Reflects a Value Differential
The originary interest rate is expressive of a value differential, which results from so-called time-preference.3 The term time-preference denotes that acting man prefers an earlier satisfaction of wants over a later satisfaction of wants.
Time-preference is always and everywhere positive, and so is the originary interest rate. This is, first and foremost, what common sense would tell us.
If the originary interest rate was near-zero, it means that you prefer two apples available in, say, 1,000 years over one apple available today. A truly zero originary interest rate implies that the actor's planning horizon or “period of provision” is infinitely long, which is another way of saying that he would never act at all but would continually push the attainment of his goals into the future.
The notion that time-preference and the originary interest rate could be zero, does not only sound absurd, it is also a logical impossibility: Positive time-preference and a positive originary interest rate are logically implied in the irrefutably true “axiom of human action.”
Human action is purposive behavior, implying the use of means to achieve ends. Action requires time (it is impossible to think otherwise). Thus, time is an indispensable and scarce means for achieving ends. As such, it must be economized, which necessarily implies that an earlier satisfaction of wants is preferred over a later satisfaction of wants.
For (praxeo-)logical reasons, therefore, time preference and the originary interest rate cannot fall to zero, let alone become negative. The implications of a negative originary interest rate cannot even be conceived by the human mind: A zero originary interest rate already implies no action ever into eternity.
Unconvincing Arguments
However, some argue that due to growing uncertainties related to longer life expectancy, people might increasingly prefer future consumption over present consumption; and that this could push time preference and the originary interest rate into negative territory.
No doubt, peoples’ time preference may decline over time, implying that savings out of current income increases while consumption declines. While time preference and thus the originary interest rate can fall, for logical reasons they cannot hit zero, though, let alone become negative.
Another argument refers to the issue of “saturation” and runs as follows: Let’s assume you have two apples, and you eat one of them. Your hunger is now saturated, so that you prefer eating the remaining apple tomorrow over eating it today. Doesn’t this prove that people may value future goods more highly than present goods, that time preference and the originary interest rate may be negative?
No it doesn’t. Non-consumption of the second apple today can easily be explained by the fact that the marginal utility of eating the apple now is lower than eating it tomorrow or the next day, even when the future marginal utility is discounted by a positive originary interest rate.
That said, the example above is misconstrued.4 It does not illustrate the relevant case, namely the case in which acting man considers alternative uses of one and the same good — and thus doesn’t prove at all that time preference and thus the originary interest rate can be negative.
The End of the Market Economy
What is the relationship between the market interest rate and the originary interest rate? In the loan market, for instance, the interest rate on loans is adjusted to the rate or originary interest. If, for instance, the originary rate of interest is 2 percent and the credit and inflation premia are 1 percent, respectively, the market interest rate would be 4 percent.
Market interest rates may become negative in real terms. In a “hampered market,” for instance, the central bank can push the real market interest rate into negative territory. However, this does not, and cannot, represent an equilibrium, as time preference and thus the originary interest rate cannot become negative.
Should a central bank really succeed in making all market interest rates negative in real terms, savings and investment would come to a shrieking halt: as time preference and the originary interest rate are always positive, “capitalistic saving” — the accumulation of goods designed for improving the production process — would come to an end. Capital consumption would ensue, throwing mankind back into poverty. It would be the end of the market economy.
It might be interesting to note in this context that, for instance, the German national socialists had called for the abolition, the prohibition of the interest rate. Now you know why: Without a positive (originary) interest rate, the market economy will cease to function.
The True Purpose of Negative-Interest-Rate Policy
For some reason, those who argue that the originary interest rate has become negative seem to overlook that the originary interest rate is a phenomena which is not confined to credit markets. It pervades all markets in which present goods are exchanged for future goods.5
For instance, the originary interest rate prevails at each stage of the economy’s time-consuming roundabout production. The originary interest rate also exists in the stock market, where investors exchange present money against a claim on future money (that is a firm’s dividend payment).
If they wanted to be consistent, the believers in a negative originary interest rate would have to call for a policy that does not only make interest rates negative in real terms in the credit market, but also in the markets for, say, stocks and housing.
However, a policy that advocates destroying firms’ values and peoples’ housing wealth wouldn’t be taken too kindly by the public at large; and those economists recommending it couldn’t expect being cheered.
The consequence of a policy of a negative real market interest rate should have become obvious by now: It is an actually perfidious policy for debasing the real value of outstanding debt; and it is a recipe for wreaking havoc on the economy.
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- 1See, for instance, Gregory Mankiw, "It May be Time for the Fed to Go Negative," New York Times, 18 April 2009; or the talk given by Larry H. Summers at the IMF Economic Forum, 8 November 2013.
- 2For important readings about the "pure time-preference theory of interest," see Jeffrey M. Herbener, ed., The Pure Time-Preference Theory of Interest (Auburn, Ala.: Mises Institute, 2011).
- 3For a thoroughgoing explanation, see Ludwig von Mises, Human Action: A Treatise on Economics, The Scholar’s Edition (Auburn, Ala.: Mises Institute, 2008), Chapter XIX: “The Interest Rate,” pp. 521 – 534.
- 4The correct example would be as follows: You are hungry and have an apple. In this case, no doubt, you would prefer eating the apple today over eating it tomorrow. In other words: You value the apple readily available today more highly than an apple readily available tomorrow.
- 5See Murray N. Rothbard, Man Economy, and State (Auburn, Ala.: Mises Institute, [1962] 2001), chapter 6 “Production: The Rate of Interest and Its Determination,” pp. 313 – 386.
