The Natural Rate of Interest: Selected Conceptual Differences among Wicksell, Mises, and Woodford and Implications for Estimation and Monetary Policy

Recent estimates of the natural rate of interest (NRI) suggest a decline over the last three to four decades. However, the real return on productive capital remained relatively stable despite this decline, and the assumed link between real interest rates and saving-investment determinants may well be unstable. This article focuses on Knut Wicksell’s “cumulative process” and his rejection of the claim by Ludwig von Mises that the NRI and financial market interest rates may be interdependent. The article agrees with arguments that Michael Woodford’s reformulation of Wicksell’s NRI is incompatible with Wicksell’s views, suggesting that the position advanced by Mises, as well as his theory of the business cycle, can help to overcome the shortcomings of current estimates of the NRI. This conclusion is supported by estimates using a time-varying parameter dynamic factor model during the period 1980–2020, when the link between interest rates and saving-investment determinants seemed stable. Impulse response functions show that monetary policy may have had a persistent downward influence on real interest rates, increasing the gap between interest rates and the real return on productive capital. Evidence supports several features of Mises’s theory of the business cycle. It follows that researchers estimating the NRI should be aware that Wicksell’s thinking on the concept evolved and that they could benefit from attention to Mises’s theory of the business cycle. The possible interaction between monetary policy and the financial sector can produce path dependence that needs to be taken into consideration when estimating the NRI.