Cumulative process

Article summary

Cumulative process is a contribution to the economic theory of interest, proposed in Knut Wicksell's 1898 work, Interest and Prices. Wicksell made a key distinction between the natural rate of interest and the money rate of interest. The money rate of interest, to Wicksell, is the interest rate seen in the capital market; the natural rate of interest is the interest rate at which supply and demand in the market for goods are in equilibrium – as though there were no need for capital markets. According to the idea of cumulative process, if the natural rate of interest was not equal to the market rate, demand for investment and quantity of savings would not be equal. If the market rate is beneath the natural rate, an economic expansion occurs and prices rise. The resulting inflation depresses the real interest rate and causes further expansion and further price increases. The theory of the cumulative process of inflation is an early decisive swing at the idea of money as a "veil". Wicksell's process was much in line with the ideas of Henry Thornton's earlier work. Wicksell's theory claims, that increases in the supply of money lead to rises in price levels, but the original increase is endogenous, created by the conditions of the financial and real sectors. With the existence of credit money, Wicksell claimed, two interest rates prevail: the "natural" rate and the "money" rate.…

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