Price-Level Stabilization Rules in a Wicksellian Model of the Cumulative Process

Abstract

Knut Wicksell's renown as a monetary theorist rests on his famous cumulative process analysis according to which price level changes stem from discrepancies between market and natural rates of interest. From his analysis emerges his celebrated policy proposal that calls for the central bank to stabilize the price level by equating the market with the natural rate. Because the natural rate is an unobservable variable impossible to target, however, Wicksell suggested that the central bank adjust the market rate in response to general prices instead. In a review of Wicksell's policy analysis, Jonung (1979) shows that he prescribed not one but rather two feedback rules for central bankers to follow in stabilizing the general level of prices. One rule, which Wicksell stated in his 1898 Interest and Prices, directs policymakers to adjust the market rate of interest in the same direction prices are moving, stopping only when those price movements cease. In Wicksell's own words:

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