March 13, 2017 Reading Time: 2 minutes


A basic tenet of macroeconomics and monetary economics is the difference between nominal variables and real variables. Nominal variables are expressed in current market prices. Real variables are adjusted to reflect the changing purchasing power of money over time (inflation or deflation). For example, the nominal interest rate is the rate that currently prevails in the market.  The real interest rate is the nominal rate less expected inflation over the time of a loan; or, if the loan has already matured, the nominal rate less what inflation actually was over the period.

Macroeconomists and monetary economists widely believe that central banks can always influence nominal variables, but can only influence real variables in the short run. If a central bank (unexpectedly) increases the money supply, this puts downward pressure on interest rates in the short run. But eventually due to rising incomes and expected inflation, the nominal rate will rise. The real rate rises along with it, restored to its initial level before the policy intervention. Thus the temporary effect on the real interest rate exists, but is transitory: expansionary monetary policy can only affect real rates in the short run.

This view lends itself naturally to the ‘primacy of the real’ in macroeconomics and monetary economists. Out there in the world is the Real Economy, more or less permanent and above the influences of policymakers (except as their behavior changes the fundamental variables on which the Form of the Real Economy depends). The Nominal Economy may be messy and changing, but the truth is all this change is illusory. While the Nominal Economy is constantly trapped in the flux of Becoming, the Real Economy is above it all, firmly ensconced in the realm of being.

There is one obvious reply to all this: when market actors make exchanges, the terms of trade, such as prices, they actually encounter are nominal, not real, variables. The real variables are inferred by economists and statisticians after the fact, based on what is often a noisy view of what inflation over the time period in question was. You could say the Nominal Economy is actually the real thing, whereas the Real Economy is a figment of social scientists’ imagination.

What if the Nominal Economy, because it is the primary arena for human action in commerce, is not the servant of, but the master of, the Real Economy? One implication would be central banks actually have much longer and more durable control over interest rates than is commonly believed. This actually makes Austrian business cycle theory (ABCT) more tenable, not less.  One of the most common objections to ABCT—that the constraints of the Real Economy make central bank influence over interest rates so transitory that there isn’t time for entrepreneurs to be misled by price signals en masse—disappears if the Nominal is Real, and the Real is artificial.

I don’t know if I find the above argument persuasive.  If it were, I would need to change my understanding of economic theory to include much more Shackle (kaleidic, non-equilibrium processes), and much less Lucas (static, equilibrium outcomes). But it’s certainly something to think about.

Alexander William Salter

Alexander W. Salter

Alexander William Salter is the Georgie G. Snyder Associate Professor of Economics in the Rawls College of Business and the Comparative Economics Research Fellow with the Free Market Institute, both at Texas Tech University. He is a co-author of Money and the Rule of Law: Generality and Predictability in Monetary Institutions, published by Cambridge University Press. In addition to his numerous scholarly articles, he has published nearly 300 opinion pieces in leading national outlets such as the Wall Street JournalNational ReviewFox News Opinion, and The Hill.

Salter earned his M.A. and Ph.D. in Economics at George Mason University and his B.A. in Economics at Occidental College. He was an AIER Summer Fellowship Program participant in 2011.

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