What is the “natural” rate?
Once again I am bereft of ideas, and thus forced to do a riff on a recent Nick Rowe post. Today I’d like to consider the term “natural rate.” Of course there are many definitions, but one of the more useful was Wicksell’s notion that interest rates were at their natural rate when monetary policy was set in a way that stabilized the price level. As you know, I prefer that monetary policy stabilize the expected future level of NGDP, along a track that grows at a predetermined rate. So here is how I would define various “natural” variables:
1. The natural rate of interest in the market rate when 12-month forward NGDP expectations are on target.
2. The natural rate of the dollar in the Forex market is the market exchange rate when 12-month forward NGDP expectations are on target.
3. The natural price of commodities is their market price when 12-month forward NGDP expectations are on target.
By now you may be noticing a disturbing pattern. Just to show I am not THAT autistic, let’s try a few more:
4. The natural unemployment rate is the not the unemployment rate when 12-month NGDP is on target. Rather, assume there was also a futures market for unemployment. Then if a 12-month forward NGDP was on target, the natural rate of unemployment would be the 12-month forward unemployment rate in the futures market.
5. What about the price of Ben and Jerry’s one pint containers of Chunky Monkey Ice Cream? The same as unemployment; the natural rate would be the 12 month forward rate in an ice cream price prediction market, assuming NGDP expectations are on target.
6. What about real estate prices? I am not quite sure. It depends on whether (and to what extent) real estate prices are sticky.
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