I just ran across this post and I apologize that I haven’t been through all the comments. I think, however, that the issue you are encountering here is a liquidity trap.
So, the actual relationship you have is that nominal interest rates tend to track NGDP growth. Now since real GDP growth is just NGDP growth minus inflation and real interest rates, are nominal interest rates minus inflation it stands to reason that real interest rates tend to track real GDP growth.
However, the problem is “How are you going to actually get 32% (30% real plus a Fed target of 2%) NGDP growth? Is the Fed supposed to commit to printing that much money? It can’t possibly.
So what you are really going to get is 5% nominal rates and 25% deflation. The deflation will act as a forced-savings mechanism because borrowers are liquidity-constrained and for savers the return on cash is high. Both groups will have less cash than they want which will cause them to reduce consumption which will dampen demand. The reduction in demand will then free up resources for capital accumulation.
If you stop and think about this, this is the world many technologists envision. The price of most things collapses, and the investment in compute explodes. This all happens, though, without a huge upsurge in interest rates.
There is actually more complexity in the transition to the long-term equilibrium but a basic liquidity trap is enough to explain why expectations of future interest rates do not rise despite the promise of rising GDP.
We’re looking at real interest rates, though! So the scenario you envision of “5% nominal rates and 25% deflation” would still show up as 30% real rates. So the monetary policy reaction function is really totally irrelevant in this sense.
PS: your 2011 blog post on a related topic has sat in my head for over a decade (“Piecing together optimal monetary policy in the singularity is a side project of mine and though it sounds silly possibly very important”… I am also interested in this topic 😊)
I just ran across this post and I apologize that I haven’t been through all the comments. I think, however, that the issue you are encountering here is a liquidity trap.
So, the actual relationship you have is that nominal interest rates tend to track NGDP growth. Now since real GDP growth is just NGDP growth minus inflation and real interest rates, are nominal interest rates minus inflation it stands to reason that real interest rates tend to track real GDP growth.
However, the problem is “How are you going to actually get 32% (30% real plus a Fed target of 2%) NGDP growth? Is the Fed supposed to commit to printing that much money? It can’t possibly.
So what you are really going to get is 5% nominal rates and 25% deflation. The deflation will act as a forced-savings mechanism because borrowers are liquidity-constrained and for savers the return on cash is high. Both groups will have less cash than they want which will cause them to reduce consumption which will dampen demand. The reduction in demand will then free up resources for capital accumulation.
If you stop and think about this, this is the world many technologists envision. The price of most things collapses, and the investment in compute explodes. This all happens, though, without a huge upsurge in interest rates.
There is actually more complexity in the transition to the long-term equilibrium but a basic liquidity trap is enough to explain why expectations of future interest rates do not rise despite the promise of rising GDP.
We’re looking at real interest rates, though! So the scenario you envision of “5% nominal rates and 25% deflation” would still show up as 30% real rates. So the monetary policy reaction function is really totally irrelevant in this sense.
PS: your 2011 blog post on a related topic has sat in my head for over a decade (“Piecing together optimal monetary policy in the singularity is a side project of mine and though it sounds silly possibly very important”… I am also interested in this topic 😊)