Real and Monetary Theories of the Interest Rate

The origin of most mainstream theories about interest rates goes back to Irving Fisher. Fisher’s concept of the equilibrium real rate of interest and the related Wicksellian concepts of “natural” or “neutral” rate are assumed to be essential for inflation-targeting frameworks. It is believed that this assumption explains the widely and confidently held conviction that monetary policy should focus on inflation expectations to keep real interest rates at a stable level to promote savings and investment. We argue that there are several problems with this approach, which relies on the principles of “real analysis” as opposed to the “monetary approach” reflected in the works of Schumpeter and Keynes. Post-Keynesian monetary theory offers a framework corroborated by central bank practices. We use some examples from the experience of the Magyar Nemzeti Bank (the central bank of Hungary) following the global financial crisis that may provide some hints for refocusing contemporary monetary policy and related theories.