CME: Interest rates should reflect market forces, not Central Bank targets
In the paper titled "Beyond Price Stability: The Role of Monetary Policy for Sustainable Growth and Social Welfare," CME chief executive Dr Carmelo Ferlito argues that the loan market does not determine interest rates in isolation.
Instead, lending rates tend to align with what he calls the "originary interest rate" — a fundamental rate that reflects society's trade-off between current and future goods.
Ferlito pointed out that in many economies, interest rates are heavily influenced by government intervention, much like price controls, warning that manipulating them can lead to economic distortions.
He emphasised that efforts to fine-tune interest rates ignore the fact that economies are complex, adaptive systems that cannot be precisely directed through top-down controls.
To clarify the dynamics of interest, Ferlito proposed distinguishing between three types of rates: the originary rate (OR), which reflects the collective time preferences of society; the market rate (MR), which arises from the interaction of loanable funds' supply and demand; and the central bank rate (CBR), which is administratively set for policy objectives.
"The central narrative of complexity science involves viewing the social system as a complex evolving system, beyond the control of government or anyone. It is more a living entity than a mechanical entity," he said.
He said economic policy should facilitate the natural development of the economy based on its own internal dynamics, rather than trying to steer or correct it using pre-set instruments.
"There are no automatic mechanisms in the economic system and therefore we cannot expect policy A to deliver exactly result B within a temporal framework X," he adds.
The paper described sustainable growth as economic expansion that occurs with little to no fluctuations while recognising that some degree of business cycles is inevitable.
Regarding employment, Ferlito cautioned against pursuing full-employment policies through monetary stimulus, noting that jobs created through artificial means are unlikely to be long-lasting.
"The new unemployment level may even be higher than the pre-stimulus situation if monetary injections encouraging demand have not only increased employment but have also stimulated the creation of new economic initiatives in the sectors so stimulated. This is why the result of inflation is worse than the problem intended to be resolved," he said.
Ferlito said monetary policy should not focus exclusively or primarily on maintaining price stability, pointing out that steady consumer prices do not necessarily prevent the formation of financial bubbles.
"Unstable economic conditions may develop, as they did in the 1920s, while the price level remains stable," he added.
He highlighted recent monetary policy errors in advanced economies, noting that many economists may have been misled by the assumption that monetary imbalances always appear as inflation.
According to Ferlito, the foundation for long-term macroeconomic stability is the alignment of the MR, NR, and OR.
"Business fluctuations can be moderated if MR is allowed to seek its path toward NR and if NR is a reflection of OR," he said.
To re-establish monetary stability, he called for a fundamental shift in thinking, suggesting that a truly new policy direction would require removing political control over the monetary system.
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