Wicksell’s ‘Natural Rate’

Wicksell’s ‘Natural Rate’


It is interesting that I am the only one to date to have calculated Wicksell’s ‘Natural Rate’. Wicksell makes it clear that he envisioned it as averaging over multiple business cycles. One can only do this with a long-term perspective. The main effort of current research has been to delve ever deeper into the detail, especially the short-term detail of data to find better answers to the markets.

I think this is the result of accepting Harry Markowitz’s 1950s definition of ‘Risk’, standard deviation of prices over a period. Being a mathematical formulation, finance became a Mecca for mathematicians, physicists and computer programmers ever since thus crowding out any approaches not heavily reliant on mathematics. No one seems to have noticed that human systems cannot be defined or understood using mathematics.

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Wicksell’s ‘Natural Rate’ is the Holy Grail with which to understand market returns and price behavior over the long-term. The ‘Natural Rate’ is something which Value Investors come to perceive even though they have never put it into a mathematical construction. Value Investor behavior is based on their internal understanding of investment returns vs. economic returns. There are few who do this. “The 1% Solution”

All of my own market understanding comes from my calculation of Wicksell’s ‘Natural Rate’.


Swedish economist Knut Wicksell advanced the concept of the natural rate in 1898. He said prices will be stable when long-term interest rates are set equal to the long-term rate of return on a nation’s capital stock, such as land, buildings, and machinery. His logic was that if interest rates were kept below the potential rate of return, investors would have a powerful incentive to exploit that gap by borrowing and investing every krona they could get their hands on—and to keep doing so until the economy ran out of workers and inflation heated up.

High inflation, then, is a clue that interest rates are below their natural level. High unemployment is the opposite, a sign that interest rates are above what nature intends and choking off growth. Such clues are the only way to infer the natural rate. “The natural rate is an abstraction; like faith, it is seen by its works,” the Welsh-born American economist John Williams wrote in 1931.

His metaphor, drawn from Protestant theology, appears in new research by another John Williams (no relation), who’s the president of the Federal Reserve Bank of San Francisco. He and Thomas Laubach, an economist on the staff of the Fed in Washington, have done some of the most careful estimates of the natural rate. They say it’s fallen sharply—by their estimate, it declined from about 5 percent in the 1960s to below 3 percent in the early 2000s. It then crashed along with the economy around 2008. Rather than recovering since, they estimate, it’s continued to drift lower, to below half a percent by the end of 2015. (All of these numbers strip out the effect of inflation.)


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Todd Sullivan is a Massachusetts-based value investor and a General Partner in Rand Strategic Partners. He looks for investments he believes are selling for a discount to their intrinsic value given their current situation and future prospects. He holds them until that value is realized or the fundamentals change in a way that no longer support his thesis. His blog features his various ideas and commentary and he updates readers on their progress in a timely fashion. His commentary has been seen in the online versions of the Wall St. Journal, New York Times, CNN Money, Business Week, Crain’s NY, Kiplingers and other publications. He has also appeared on Fox Business News & Fox News and is a RealMoney.com contributor. His commentary on Starbucks during 2008 was recently quoted by its Founder Howard Schultz in his recent book “Onward”. In 2011 he was asked to present an investment idea at Bill Ackman’s “Harbor Investment Conference”.

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