The Unnatural Rate Of Interest

Economists believe that there is a "natural" rate of interest.  When interest rates are held below the natural rate, the economy will expand and produce inflation.  (Milton Freidman expanded this notion to the natural rate of unemployment.  When unemployment is below the natural rate it will produce inflation).  The Fed has been using monetary policy to keep interest rates below the "natural" rate but we have not had inflation.  That is most likely explained by the fact that we seldom get inflation when we have high levels of unemployment. The Fed is using monetary policy, in part, to bring the unemployment rate down.

Conventional wisdom suggests that we need to balance the federal budget or we will be faced with higher interest rates.  That has not happened.  The explanation by those who have absorbed the conventional wisdom is that the Fed is keeping interest rates low through monetary policy.  Somehow the Fed has the power to alter the natural rate of interest.  Other governments have also been using monetary policy to keep interest rates low without producing inflation. Interest rates are also low in many other countries in which monetary policy is not being used to keep interest rates low.  There must be another explanation for the low cost of borrowing by governments that are creditworthy.  Conventional wisdom will not accept another reason.  The specter of higher interest rates is necessary to keep the pressure on governments to balance short term budgets.