Knut Wicksell

By Emeka Obi

Knut Wicksell was the most original monetary theorist between Ricardo and Keynes, and for most of his life Sweden treated him as a scandal rather than a scholar. Born in Stockholm in 1851, orphaned young, he drifted through mathematics and physics before economics seized him in his thirties; he was nearly forty when he began the work that mattered. His problem was the oldest in monetary economics: what connects money to prices? The quantity theory said more money means higher prices, but could not say how. Wicksell's answer, in Interest and Prices (Geldzins und Güterpreise, 1898), was the cumulative process — the single most fertile idea in the history of central banking. Imagine, he said, a pure credit economy where banks lend at a money rate of interest. There exists, beneath the monetary surface, a natural rate — the rate that would equate saving and investment in a barter economy, determined by real productivity and thrift. If the banks set their money rate below the natural rate, borrowing is artificially cheap: investment outruns saving, demand outruns supply, and prices rise — and keep rising, cumulatively, as long as the gap persists. If the money rate is above the natural rate, the process runs in reverse toward deflation. The price level, in other words, is governed by the gap between two interest rates — and the central bank, by moving its rate, steers the whole economy. It is difficult now to grasp how revolutionary this was: Wicksell had invented, in 1898, the conceptual framework every modern central bank uses — the policy rate versus the neutral rate, the output gap avant la lettre, inflation as the symptom of a rate misalignment. His Lectures on Political Economy (1901–1906) systematized the whole of economics on marginalist lines for Scandinavian students and spread his monetary theory across Europe. He was also, inconveniently, a radical: an atheist, a Malthusian who preached contraception, a republican who was jailed for two months in 1908 for mocking the king — Sweden's universities kept him at arm's length until Lund finally gave him a chair in 1904, when he was fifty-three. He died in 1926, just as his ideas were conquering the world through others: the Stockholm School (Myrdal, Lindahl, Ohlin), Keynes's Treatise on Money (1930), Hayek's cycle theory, and eventually the entire modern apparatus of inflation targeting — which is, at bottom, Wicksell's cumulative process with better statistics.

Impact on civilization

Wicksell's impact is the intellectual foundation of modern central banking. The natural rate of interest — r-star, in today's jargon — is the lodestar of every inflation-targeting central bank: the Federal Reserve, the ECB, and their peers all set policy by estimating the gap between their rate and the neutral rate, exactly as Wicksell prescribed in 1898. His cumulative process is the ancestor of every modern account of how monetary policy transmits to prices. Beyond money, his Finanztheoretische Untersuchungen (1896) founded modern public finance: the unanimity rule for public expenditure — that taxes are legitimate only for spending citizens would unanimously approve — became the seed of public-choice theory and Buchanan's constitutional economics. The Stockholm School he inspired gave macroeconomics its period analysis and its first systematic treatment of expectations. He published in Swedish and German and was read late; the delay only proves the originality — the world needed thirty years to catch up with what he had already worked out.