Free Markets Do Not Need Negative Interest Rates

Martin Wolf, associate editor and chief economics commentator at the Financial Times, seems to have forgotten the nature of interest rates and their coordinating role. According to him, central banks are not to blame in the persistence of low or negative interest rates. He writes: “We must regard ultralow rates as symptoms of our disease, not its cause.”

Wolf then goes on to claim that “negative interest rates are not the fault of central banks.” It’s difficult to see how Wolf can justify this claim. Never under the gold standard, never under free banking systems, and never in a free market economy have interest rates been negative. Indeed, the interest rate on the unhampered market reflects the social rate of time preference, it is the “price of time.” And as it is a universal law of human action that time preference must always be positive, interest rates cannot possibly be negative on the free market.

An almost line-by-line critique of this article would be necessary, for the arguments in it are so ill-conceived and fallacious that it is hard to ignore them. I will, however, criticize only several points.

In particular, I’ll address: (1) the idea that central banks have nothing to do with negative interest rates, (2) the idea that a savings glut/investment dearth does exist, and (3) that the idea of low interest rates is a consequence of low productivity growth.

What’s Responsible for Negative Rates?

There is no market justification for negative interest rates. Nevertheless, in the second paragraph of Mr. Wolf’s article, we can read:

The world economy is suffering from a glut of savings relative to investment opportunities. The monetary authorities are helping to ensure that interest rates are consistent with this fact. Ultimately, market forces are determining what savers get. Alas, the market is saying that their savings are not worth much, at least at the margin.

This paragraph suffers from multiple flaws. First, there is the argument which claims todaythat the market “determines” the interest rate. But, in a world where credit is highly influenced by the policies of the monetary authorities, it is clear that interest rates are not determined by the market. Thanks to open market operations, central banks can reduce the interest rate to well below its free-market level, leading to malinvestment and, in fine, to crisis.

What Mr. Wolf might mean by this, however, is that the market adjusts to the conditions set by central banks. But this is no argument at all for central banking and negative interest rates. The market “adapts” virtually to anything: crime, regulations, inflation, etc. If an increase in crime occurs in a particular city and that consequently the price of real estate decreases, should we say that crime did not cause this decrease since “ultimately, market forces are determining the price of real estate”? The fact that market forces adjust to government monetary policies cannot in any case justify government counterfeiting operations the same way it cannot justify stealing, killing, or any other aggression.

The Non-Existent Savings Glut

A second problem of this particular paragraph is that if there really was a glut of savings, it follows that interest rates should decrease by themselves without the need of any “monetary authorities.” As long as there is no violent intervention of the State in the free-market, no “saving glut” can possibly happen. Martin Wolf affirms otherwise and takes us back to the theory developed by Alvin Hansen, the leading Keynesian economist in post WWII America.

According to Hansen, depression or “secular stagnation” are the result of a lack of investment opportunities. He even argues that the Great Depression was the result of an investment dearth due to slow population growth and the absence of innovation. Today, this theory is being revived with the secular stagnation hypothesis. One of its most prominent advocate, Laurence H. Summers, writes:

Alvin Hansen proclaimed the risk of secular stagnation at the end of the 1930s, only to see the economy boom during and after World War II. It is certainly possible that some major exogenous event will occur that raises spending or lowers saving in a way that raises the FERIR [full employment real interest rate] in the industrial world and renders the concerns I have expressed irrelevant. Short of war, it is not obvious what such events might be. Moreover, most of the reasons adduced for falling FERIRs are likely to continue for at least the next decade.

It happened that Murray Rothbard criticized the “dearth of investment opportunities” explanation of depression and of secular stagnation in his America’s Great Depression (pp. 68–72). As Rothbard noted, it is easy to conclude that only change in ultimate givens (population, technology …) can create new investment if one derives his reasoning from the Walrasian general equilibrium construct where conditions and preferences are held constant. Thus, if new investment is considered as the main explanation of prosperity and depression, it follows that only changes like war, innovation, population growth, etc., can open new investment opportunities.

The problem with the theory defended by Hansen, Summers, and Wolf is that it leaves out the role of time preference as a determinant of investment. Indeed, there are always investment opportunities since human needs are insatiable. But as resources are scarce, savings included, it is necessary to prioritized in what we should invest in, in accordance to our time preference schedules. As Rothbard puts it, “it is time preferences (the ‘tastes’ of the society for present vis-à-vis future consumption) that determines the amount that individuals will save and invest.”

Therefore, Rothbard continues:

What we need, in short, is savings: this is the factor limiting investment. And saving, in turn, is limited by time-preference: the preference for present over future consumption. Investment always takes place by a lengthening of the processes of production, since the shorter productive processes are first to be developed. The longer processes remaining untapped are more productive, but they are not exploited because of the limitations of time-preference. There is, for example, no investment in better and new machines because not enough saving is available.

Thus, we must conclude that there is no such thing as a “saving glut.”

The Need for Real Savings

On the contrary, we need more real savings to promote economic growth. What we have in excess however is fiduciary credit resulting from central banks inflationary policies. Such policies will exacerbate the boom and bust cycle. Additionally, central banks’ ultra-low interest rates policy will induce entrepreneurs to embark upon less profitable projects and will relax the constraint they have on the free market to serve the most urgent, not yet satisfied, needs of the consumers.

As Mises puts it in Human Action, the interest rate on the unhampered market “prevents him [the entrepreneur] from embarking upon projects the realization of which would be disapproved by the public because of the length of the waiting time they require. It forces him to employ the available stock of capital goods in such a way as to satisfy best the most urgent wants of the consumers.” Negative interest rates are a recipe for disaster. By misleading investment, they are a fundamental cause of economic stagnation and depression.

The idea that it is the lack of investment opportunity which is responsible leads to further fundamental mistakes, especially concerning the formation of the interest rate. Thus, Martin Wolf writes:

The savings glut (or investment dearth, if one prefers) is the result of developments both before and after the crisis. Even before 2007, real long term interest rates were in decline. Since then, weak private investment, reductions in public investment, a slowing trend growth of productivity and the debt overhangs bequeathed by the crisis have interacted to lower the equilibrium real rate of interest. For a while, strong post crisis demand in emerging economies partially offset these trends. But now that has also faded away.

The most striking fallacy in this paragraph is the completely false claim that there exists a causal relationship between productivity and the interest rate. Austrian theory demonstrates that there is no such thing. Interest rates do not depend on productivity, as many classical economists held, but on time preference. It is not the higher productivity of longer production processes that drives the interest rate, but the other way around.

The interest rate depends on the social rate of time preference and explains why shorter processes of production are used despite the existence of longer processes that would render a higher output by unit of input. As Israel Kirzner puts it, “no productivity considerations can possibly enter at all into the explanation offered for interest.”

We Must Stimulate Demand

It is manifest that Mr. Wolf’s attempt to exonerate central banks of their responsibility concerning negative rates is based on Keynesian propositions that central banks must do something. Martin Wolf believes that the stability of our economies rely on governments and central banks, that interest rates must be “made consistent” and aggregate demand must be “balanced.” He does not seem ready to recognize however that the unintended consequence of the central banks intervention he asks for is the current situation of negative interest rates. He writes:

Some will object that the decline in real interest rates is solely the result of monetary policy, not real forces. This is wrong. Monetary policy does indeed determine short term nominal rates and influences longer term ones. But the objective of price stability means that policy is aimed at balancing aggregate demand with potential supply. The central banks have merely discovered that ultralow rates are needed to achieve this objective.


After reading this last paragraph, it is legitimate to ask oneself what is the limit to Mr. Wolf’s potential for self-contradiction. Indeed, he claims that central banks have nothing to do with negative interest rates and, simultaneously, that not only central banks do influence interest rates, but also that they “have discovered that ultralow rates are needed.” Therefore Mr. Wolf made it clear to the reader, despite his intentions, that central banks are very much responsible for negative interest rates.

Also, we should underline that the “price stability” Martin Wolf seems to favor is an illusory goal. An expanding economy can very well function with price deflation. The idea that governments should manipulate aggregate demand or supply in order to ensure price or economic stability is fallacious. Indeed, if one thing should be learned from classical economics, it is that aggregate supply and aggregate demand are two aspects of the same thing and that, as Ricardo wrote, “men err in their productions, there is no deficiency of demand.” There is absolutely no need for a political authority to equate aggregate demand and supply. It follows that Mr. Wolf’s last excuse for central bankers vanishes.

The allegation that negative interest rates are somehow natural or answering to the needs of the economy is absurd, and without the interference of central banks and governments, the negative interest rate topic would be non-existent.