Reconsidering the role of interest rates in monetary policy: An empirical examination of the relationship between interest rates and nominal GDP growth in the U.S., U.K., Germany and Japan

Date

2017-10-10

Advisors

Journal Title

Journal ISSN

ISSN

Volume Title

Publisher

Elsevier

Type

Article

Peer reviewed

Yes

Abstract

The rate of interest – the price of money – is said to be a key policy tool. Economics has in general emphasised prices. This theoretical bias results from the axiomatic-deductive methodology centring on equilibrium. Without equilibrium, quantity constraints are more important than prices in determining market outcomes. In disequilibrium, interest rates should be far less useful as policy variable, and economics should be more concerned with quantities (including resource constraints). To investigate, we test the received belief that lower interest rates result in higher growth and higher rates result in lower growth. Examining the relationship between 3-month and 10-year benchmark rates and nominal GDP growth over half a century in four of the five largest economies we find that interest rates follow GDP growth and are consistently positively correlated with growth. If policy-makers really aimed at setting rates consistent with a recovery, they would need to raise them. We conclude that conventional monetary policy as operated by central banks for the past half-century is fundamentally flawed. Policy-makers had better focus on the quantity variables that cause growth.

Description

open access article

Keywords

Interest rates, Economic growth, Monetary policy, Monetary transmission, Prices vs. quantities, Quantity constraints, Resource constraints, Quantity theory of credit

Citation

Lee, Kang-Soek and Werner, R.A. (2018) Reconsidering the role of interest rates in monetary policy: An empirical examination of the relationship between interest rates and nominal GDP growth in the U.S., U.K., Germany and Japan, Ecological Economics, 146, pp. 26-34

Rights

Research Institute

Finance and Banking Research Group (FiBRe)