Chapter 11 section 3 is a muddle.

It does seem plausible that a change in inflation expectations might affect the MEC and the interest rate in ways that are not exactly the same, but that’s as far as I can get with it.

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]]>PP = Purchasing power of total money stock

PP = Debt (D) / Price Level (P)

D = PP * P

dD/D = dPP/PP + dP/P

Again:

dN/N + dD/D = dQ/Q + dP/P

Substituting in for dD/D:

dN/N + dPP/PP + dP/P = dQ/Q + dP/P

Canceling out the inflation rate terms:

dN/N = dQ/Q – dPP/PP

Nominal Interest Rate = Real Interest Rate – % Change in purchasing Power

Hypothetical:

dN/N = 5% : Nominal Interest Rate

dD/D = -7% : Credit Growth Rate

dP/P = 4% : Inflation Rate

dPP/PP (-11%) = dD/D (-7%) – dP/P (4%)

dQ/Q (-6%) = dN/N (5%) + dPP/PP (-11%)

Same result – real interest rate is negative 6% (not positive 1% as implied by the Fisher equation). That is because the positive inflation rate (4%) is coupled with a decline (7%) in the total amount of debt / money in circulation resulting in a negative 11% decrease in the purchasing power of the money stock.

Obviously, I am equating debt with money via 100% reserve banking (a dollar can be only lent once). Things are complicated by fractional reserve banking (more debt exists than the total money in circulation) and by central bank open market purchases. But that is a subject for another day.

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]]>“One of the most puzzling passages in the General Theory is the attack (GT p. 142) on Fisher’s distinction between the money rate of interest and the real rate of interest where the latter is equal to the former after correction for changes in the value of money.”

Hypothetical:

dN/N = 5% : Nominal Interest Rate

dD/D = -7% : Credit Growth Rate

dPY/PY = 1% : Productivity Growth Rate

New equations – Inflation Rate and Real Interest Rate:

dP/P (4%) = dN/N (5%) – dPY/PY (1%)

dQ/Q (-6%) = dD/D (-7%) + dPY/PY (1%)

Notice that despite a positive nominal interest rate of 5% greater than a positive inflation rate of 4%, the real interest rate is negative 6%, not positive 1% as implied by the Fisher equation.

What Fisher (and Keynes) fail to acknowledge is that both inflation AND credit / monetary contractions reduce the total value of money in circulation.

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]]>PY = Q / D = Productivity

D * PY = Q

dD/D + dPY/PY = dQ/Q

dD/D = dQ/Q – dPY/PY

Previous equation:

dN/N + dD/D = dQ/Q + dP/P

Substituting our equation for credit growth rate (dD/D):

dN/N + dQ/Q – dPY/PY = dQ/Q + dP/P

Cancelling out dQ/Q on both sides

dN/N – dPY/PY = dP/P

dN/N = dP/P + dPY/PY

The real interest rate and the credit growth rate disappear from the equation and are replaced with the growth rate in productivity (dPY/PY).

Nominal Interest Rate = Inflation Rate + Productivity Growth Rate

This is the part that I believe Keynes and Fisher both miss on.

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]]>Did Keynes or Fisher consider the effect of debt quantities on economic variables such as inflation?

IntN% = dN / N = Nominal Interest Rate

IntR% = dQ / Q = Real Interest Rate

Inf% = dP / P = Inflation Rate

D% = dD / D = Debt Growth Rate

Fisher Equation (Interest rate only)

IntN% = IntR% + Inf%

This seems incomplete without a debt growth rate term.

dN/N + dD/D = dQ/Q + dP/P

IntN% + D% = IntR% + Inf%

Do increases in the nominal interest rate drive the inflation rate higher (as implied by the Fisher equation) or is it some combination of both debt growth and the nominal interest rate?

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]]>I’m not sure I follow this. What sort of interest rates and what markets are you referring to?

In the real world, nominal rates are transacted in financial markets, but I don’t think those are loanable funds markets are they? They simply involve swapping one form of financial asset (some form of money) for another, and do not involve any supply of or demand for actual savings.

If there are any markets in the real world where both: a) transactions actually take place and b) loanable funds are exchanged (in the sense that one party saves and the other dis-saves), then these must actually be the markets like those for current commodities, where a current price is transacted, rather than an interest rate. Of course, given expectations of future prices, determination of the current price may imply some form of real interest rate. Is that what you meant?

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]]>It is fairly obvious (at least it was to Robert-son) that Keynes’ began by focusing on the deter-mination of the actual rate of interest that exists in the real world at any given point in time by way of a Marshallian partial-equilibrium analysis of this problem. In the process, he came to the conclusion that, given the fact that in a monetary economy money (or the creation of debt) is required as a medium of exchange, it is logically impossible to understand or explain the way in which decision-making units determined the rate of interest in terms of their choices with regard to the flows of saving and investment or of the supply and demand for loanable funds. The only way he could make sense out of the way in which decision-making units determined the rate of interest was in terms of their choices with regard to the supply and demand for the stock of money. I have explained the process by which Keynes came to this conclusion in detail here: http://www.rweconomics.com/htm/Pro.htm

What I find interesting with regard to the way in which the real rate of interest is assumed to be determined in The General Theory is that Keynes did not actually examine the way in which this rate is determined. Instead, he took expectations to be exogenously determined and explained how the money rate of interest is determined given expectations. He then examined how changes in expectations affect the system. I believe it is worth noting that Fisher took the same approach in The Theory of Interest. (pp. 43-6)

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