Men are always forced to choose between satisfaction in nearer and remoter periods of the future. We cannot even think of a world in which originary interest would not exist as an element in every action. FULL ARTICLE by Ludwig von Mises

Source link: http://archive.mises.org/12658/the-nature-of-interest/

# The Nature of Interest

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http://mises.org/journals/qjae/pdf/qjae5_4_7.pdf

hülsmann’s revision of mises’ theory of interest is a must-read as well.

Suppose I have $100 which I value less than $110 a year later, while another would rather have $100 today than $110 a year later. Isn’t that trade all that is needed to understand the role of interest?

Suppose, in a three person economy, person one with $100 is satisfied postponing consumption for 9.9% interest, while person two with $100 wants, say, 12%. Now suppose person three owns a piece of capital equipment that can provide an 11% return on a $100 investment. The interest rate would be greater than 9.9% but less than 11%.

Now, instead, suppose the machine can provide a 20% return on a $200 investment. The interest rate would be greater than 11%. How, therefore, does the productivity of capital not influence the interest rate?

Alex, if person one is satisfied with receiving 9.9% interest, wouldn’t person three accept this, rather than pay more? Why would he care about person two at all?

In my example above, person one only has $100. The capital owner needs $200. Assuming the capital owner cannot discriminate in his payment of interest, the interest rate would be 12%.

Say person three owns a 100 tree forest and produces lumber. Suppose the rate of growth in the trees (and potential lumber production) is 8%. Person three spends all his current income 8%x100 trees’ worth for consumption, and would not postpone any current consumption for less than a 15% return. In this scenario, person one may lend to person two, but no investment would take place. However, suppose the growth rate of the forest is 15%. Person three could get his 8 units of consumption from cutting the forest, which would then grow to (115-8)x1.15=123.05 units of lumber in one year. Or, he could pay person one and people like him 10% to borrow the value of 8 units of lumber for his consumption and allow the forest (115 lumber-units) to grow at 15%, which would see his wealth accumulate to 115×1.15=132.25 lumber units in one year.

If there is no real capital productivity, then lending and borrowing would take place only between consumers, in which case time preference would solely determine the interest rate. But in the case of real capital productivity, such productivity also plays a part in determining the interest rate.

My immediate reaction to this excerpt is to think of a counterexample: I wouldn’t save my money in the bank if I was offered 2% interest, but would if offered 50% interest: therefore the interest rate influences the rate of saving. I am probably misunderstanding what he is talking about.

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