The mysterious real interest rate - the one typically denoted as r in economic theory - does not have a real life counterpart. This is a problem for economic theory. And it is a major problem for policy makers relying on monetary policy to boost economic activity.
While we think of the nominal interest rate minus inflation as getting close to the theoretical concept of real interest rates, changing this value in practice through central bank operations does not actually change the real return on capital and stimulate investment through that channel.
Why?Fresh economic thinking
Because the price of capital is determined by the interest rate! We have known this for a long time. Joan Robinson wrote about the circularity of reasoning when we measure the quantity of capital by its price. She was ignored. As I expect to be.…
The mysterious real interest rate of economic theory