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The Idolatry of Interest Rates Part I

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The Idolatry of Interest Rates Part I

Chasing Will-o’-the-Wisp

GMO,

5 min read
5 take-aways
Audio & text

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Some economic assumptions are so deep-rooted that experts forget to question their origins.

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9

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Some economic assumptions are so deep-rooted that market experts, policy makers and economists forget to question their origins. One of these is the equilibrium real interest rate, the mythical rate at which the economy is in balance and to which central bankers adapt their policies in order to drive the economy faster or slower. Investment expert James Montier offers his iconoclastic but thought-provoking take on the notion, which getAbstract believes will intrigue – or infuriate – financial and economic professionals.

Summary

Central bankers and economists obsess over the concept of an equilibrium real interest rate, which former Fed chairman Ben Bernanke defined as “the real interest rate consistent with full employment of labor and capital resources.” While this hypothetical rate shifts over time – higher when the economy is thriving, lower when it’s not – policy makers use it to guide their monetary policy. In current theory, a central bank’s management of interest rates should trend toward the real equilibrium interest rate. Alas, little evidence of such a rate exists, and it’s unlikely the notion helps monetary policy. Rather, it is a sign of groupthink...

About the Author

James Montier is on the asset allocation team of the investment management firm GMO.

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