Hi Jason,

Your blog gave me some serious matter for thought, but I have to admit I am not convinced by the option of using productivity as a measure of interest rate. Irving Fisher in his Theory of Interest cautions precisely against using productivity measures as interest rates. Doing this presupposes that interest rates move forward in time, when in fact it is the inverse. The true nature of Interest rates is that they are a discount factor, the ratio of a future income to a present value of an asset. One should therefore think backwards, from future to present, with interest rates and not the other way around. Fisher did admit that productivity can play an important role in the evolution of the future income you would be discounting, but he argued that interest rates and productivity are not the same thing and taking one for the other a "pitfall" that should be avoided. He argued with bushels of wheat, and basically said that, if the yield of a piece of land where to suddenly be multiplied by 2, for instance, the increase in income potential from the yield would increase the value of the piece of land too, so it is not guaranteed that the increase in productivity would have at all an impact on the ratio of the flow of future income to the present value of the land; that is, the interest rate. I think you could safely extrapolate this example to the economy as a whole to discard productivity as an alternative measure of the risk-free interest rate.

According to Fisher, the true nature of interest rates would have more to do with the inter temporal choices we make when sending resources back and forward in time and the value placed on present and future.

I also have existential problems with the risk-free rate and the use of the T-Bill rate as an approximation to its measure. But it always makes me think of an engineering joke one friend of mine told me once. It's "How would an engineer model a cow?" The answer was: "Let us assume the cow is a sphere..." My friend is an aerospace engineer, so if the people who build the planes we fly in can live with this kind of approximation to reality, I think I could live with the T-Bill as a proxy for the risk-free asset.