Superphysics
Interest Rates According to Different Economists
5 minutes • 882 words
Table of contents
THERE is not much discussion of interest rates in the works of Marshall, Edgeworth or Professor Pigou*.
Superphysics Note
Alfred Marshall = Interest is the price of capital
Principles of Economics
Interest is the price paid for the use of capital in any market.
It tends towards an equilibrium level such that the aggregate demand for capital in that market, at that rate of interest, is equal to the aggregate stock forthcoming there at that rate.
If the market is small, such as a town, an increased demand for capital in it will be promptly met by an increased supply drawn from surrounding districts or trades.
But if we are considering the whole world, as one market for capital, we cannot regard the aggregate supply of it as altered quickly and to a considerable extent by a change in the rate of interest.
This is because the fund of capital is the product of labour and waiting. A rise in interest rates would incentivize the extra work and waiting, resulting in the total stock of capital. But it would not quickly amount to much, compared with this actual result.
An increase in the demand for capital will therefore raise interest rates ahead of the increase of supply. This will cause capital to withdraw itself partially from those uses in which its marginal utility is lowest.
The rise in interest rate will increase the total stock of capital only slowly and gradually, (p. 534)
His version is applicable to old investments of capital only in a very limited sense.
For instance, a trade capital of 7b pounds is invested in various industries this country at 3% net interest. This is convenient, but not accurate.
It is more accurate to say that if the net interest rate on new investments in each of those industries [i.e. on marginal investments] is 1%, then the aggregate net income from the total trade-capital invested, if capitalised at 33 years’ purchase (on 3% interest), would amount to 7b pounds.
The value of capital investment in land, building, etc. is the aggregate discounted value of its estimated future net incomes [or quasi-rents]. If its prospective income-yielding power should diminish, its value would fall accordingly and would be the capitalised value of that smaller income after depreciation” (p. 593).
Superphysics Note
Pigou = Interest is the reward of waiting for money to become capital
Economics of Welfare p.163
The nature of the service of ‘waiting’ has been much misunderstood. Sometimes it has been supposed to consist in:
- the provision of money or
- the provision of time
People have argued that no contribution whatever is made by either to the dividend. Neither supposition is correct.
‘Waiting’ simply means postponing consumption which a person has power to enjoy immediately, thus allowing resources, which might have been destroyed, to assume the form of production instruments.
The unit of ‘waiting ‘ is, therefore, the use of a given quantity of resources — for example, labour or machinery — for a given time.
Generally, we may say that the unit of waiting is a year-value unit, or, in the simpler, if less accurate, language of Dr. Cassel, a year-pound.
The common view is that the amount of capital accumulated is necessarily equal to the amount of ‘savings’ made in it. This is not totally correct because not all savings become capital. Instead, many are wasted.
Pigou believes that interest rate is determined by demand and supply of real capital which is in the control of a bank.
*Industrial Fluctuations (1st edn.), pp. 251-3
He argues that:
When bankers lend more to businesses, they make a forced levy of real things from the public. Thus, they increase the stream of real capital available for them, and cause a fall in the real rate of interest on long and short loans alike.
The bankers’ rate for money is bound by a mechanical tie to the real rate of interest on long loans. But this real rate is not determined by conditions wholly outside bankers’ control.
I am perplexed by Marshall’s account.
I think this is caused by Marshall taking the concept of “interest”, which belongs to a monetary economy, into a treatise which takes no account of money*.
“Interest” has really no business to turn up at all in Marshall’s Principles of Economics, — it belongs to another branch of the subject.
Superphysics Note
In his Economics of Welfare, Professor Pigou leads us to infer that:
- the unit of waiting is the same as the unit of current investment and
- the reward of waiting is quasi-rent.
He never mentions interest — which is as it should be.
The interest rate scarcely plays a larger part in either of his 2 studies:
- His Industrial Fluctuations is a study of fluctuations in the marginal efficiency of capital
- His Theory of Unemployment is a study of what determines changes in the volume of employment (assuming there is no involuntary unemployment)
Nevertheless, these writers are not dealing with a non-monetary economy (if there is such a thing). They quite clearly presume that money is used and that there is a banking system.
