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Source link: http://archive.mises.org/9524/hey-economists-money-and-interest-are-different-things/

Hey, Economists! Money and Interest Are Different Things

March 2, 2009 by

There’s an old joke where the first guy says, “What’s the difference between drapes and toilet paper?” The second guy says, “I don’t know, what?” Then the first guy responds, “You are not allowed in my house!”

After watching the “expert” economists debate our financial crisis during the past year, I realize that we can modify the joke. Today I would ask the econobloggers and op-ed writers, “What’s the difference between monetary policy and interest rates?” If the economist answered, “I don’t know, what?” then he is not allowed to advise the government. Any “expert” who confuses money and interest is eventually going to give horrible recommendations under certain conditions. FULL ARTICLE


fundamentalist March 2, 2009 at 10:44 am

Very informative! Thanks! This explains why the salaries in the financial industry have been so high for so long.

Stephen Grossman March 2, 2009 at 11:08 am

How can you integrate this with Mises’ view that interest rates are time preferences?

Tim Kern March 2, 2009 at 11:14 am

Again, Murphy gets it right! “If the Fed doubles the money supply, in the long run, that will roughly double the prices of all goods and services. But if the Fed restricts the injection of new money into only the hands of a few privileged recipients, those people will be at a fantastic (albeit temporary) advantage relative to everyone else in the economy. They will get their hands on the billions in new dollars, while prices still reflect the old reality. The new money will then flow from sector to sector, pushing up prices as it ripples throughout the economy. But the last people in line receiving the new influx of twenty- and hundred-dollar bills will be much poorer than others, once prices settle down.”

People in general (and in the media) seem to think that “inflation” is “a general rise in prices.” Of course, that is like blaming the iceberg for hitting the HMS Titanic.

Overall prices can’t rise unless there is additional money in the hands of those who bid up the prices, and that’s why we can have devastating inflation without a rise in the CPI — as Murphy points out, the money isn’t going to consumers, and the price of toilet paper (or drapes) isn’t going up!

No, money and interest are very different — interest is the price of money, and when the price of something is dropped to zero by its supplier, its value among the buyers drops. The only thing that keeps our “money” worth anything is its ability to keep us out of tax prison.

So, why does the government want it? We economists fail to see that the currency of governments is not currency — it is power. Understand that, and it all makes perfect sense.

Lucas M. Engelhardt March 2, 2009 at 11:57 am

One small quibble:

The $10 million can actually grow into a potentially infinite quantity of money, as the 10% reserve requirement we commonly use in examples is only on a specific (and small) set of deposits. Most deposits (savings accounts and time deposits) have a 0% reserve requirement. So the $10 million can potentially grow to infinity, in theory.

@Stephen Grossman

Actually, I wouldn’t hold my breath on that. Dr. Murphy is a critic of the Misesian time preference theory of interest (I’m one that thinks he has some good points, and am working on a small variation of time preference theory to help address some of them). But, given that, I doubt we can expect Dr. Murphy to integrate the two.

Eric March 2, 2009 at 12:27 pm


Ok, if I had that question on an economics test, here’s how I’d take a crack at it.

First I would state that the laws of supply and demand work the same with money as with any other goods.

I would then add that the central bank does not directly set interest rates – in the world markets. Rather, it attempts to adjust interest rates up or down by increasing (common) or decreasing (rare) the supply of money over time. By adjusting the supply of money, they hope to affect the interest rates (price) of money. This leaves demand as the 3rd item in our supply and demand relationship.

However, the central bank cannot directly control the demand for money. When people have a higher demand for money, this means they have a desire to hold money NOW. Since NOW is a point in time, a higher demand for money now means that there is a lower relative demand for money in the future.

This is what Mises means by time preferences (more or less desire for money now vs. the future).

In a free market (free from force used or threatened by government and central banks) supply and demand of money (or anything else) are in balance and their ratio is signaled by prices. Changes in either the supply or demand will be reflected in changing prices. Since interest is simply the “price” of borrowing money, the time preferences of savers and borrowers will affect the price of money NOW vs. money in the future. If more people want money today, the price will rise; if more people want money tomorrow, the price (today) will drop.

In this way, the demand side of the equation will be the determinant of the prices of money, except for the influence that the supply of money has. In a free market with a stable money supply, the demand for money would largely set the price of money – or the interest rates.

Thus without an inflating central bank, interest rates would be primarily set by demand. And since demand for money is another way of looking at time preference, the interest rate would be determined primarily by time preferences.

Greg Ransom March 2, 2009 at 12:46 pm

Great article.

Abhilash Nambiar March 2, 2009 at 1:02 pm

I am being picky on Robert Murphy? I think I am about to be. People I like tend to have more trouble with me than people I do not like. It runs in the family. Of course if you are picky, you must expect to get picked upon. So I will brace myself…

So now for my picky nature part to reveal itself. It is all very subtle things actually. But never the less I think they are important. They do not exactly contradict the article too, but maybe refine it. So don’t get me wrong here.

The Feds do not exactly print their way out of an economic crisis. They try to resolve the economic crisis and prints money as a consequence.

Also technically speaking they do not set the interest rate at any level. What they really do is decide what they think the interest rate ought to be and then engaging in market transactions to achieve it. That is where the buying and selling of bonds come into play. Other cash rich players in the market can try to do that of course, but having a monopoly over money production means the feds will always win out. So it is better not to pick a fight with them, in the markets.

So they do print their way out of when cornered. But it is not printing for its own sake. No one said it was. I just wanted to make it explicit. It is basically the long (and caring) arms of Uncle Sam deciding what is good (and bad) for us, whether we like it or not. A case of government treating us like children. That is the path to socialism.

Now for a specific quote

Another name for private-sector buyers of debt is savers.

It seems to be a mistake. If you sell a bond you are putting yourself in debt. You are borrowing money, you are a borrower. If you are buying that bond, you are financing that debt with your money.Your money that you hope to get back. So you are a lender.

Lending is not the same as saving. There is a fine line. You can after all save your money by keeping it under your pillow, or the secret safe behind your book case. Lending means there is interest.

When you put your money in a ‘savings’ account or a CD, you get interest on it. You have in fact gradually progressed from a saver to lender, all be it a very conservative one. In their books, your money is in fact recorded as a liability. A loan that the bank needs to pay back to you. Meanwhile they hope to make money out of it by lending it sensibly themselves.

So why do they call it a ‘savings account’? Because they are targeting savers. They want to make money out of savers. So it is in their advantage to blur the line between saving and lending. Even Robert Murphy can fall for that one.

Inquisitor March 2, 2009 at 1:41 pm

“Actually, I wouldn’t hold my breath on that. Dr. Murphy is a critic of the Misesian time preference theory of interest (I’m one that thinks he has some good points, and am working on a small variation of time preference theory to help address some of them). But, given that, I doubt we can expect Dr. Murphy to integrate the two.”


gene March 2, 2009 at 3:23 pm

Abhilash is right, saving and lending “shouldn’t” be the same thing. They have been blended in our economy to benefit the banks and again multiply money.
And it is a double whammy!!!!the prevalent monetary policies force us to “not save”. Without inflation [and elimination of bank monopoly of investment] true saving would be a wise option and a “governor” on the economy, preventing overheating and promoting even, consistent and what we might percieve from our perverted viewpoint, “slow” growth, relative to real need.
It is monetary monarchy. confiscating the “fruits” of work, money, either devaluing it by endlessly growing its supply, or stealing interest off it through the banking system. the problem they are facing today is that they just got a bit too carried away with the process.

pbergn March 2, 2009 at 3:30 pm

Good article; somewhat off target albeit.

For example, after writes:

“[...]When the Fed “cuts interest rates,” what it’s really doing is creating money out of thin air and handing it over to bond manufacturers.[...]“

Lowering interest rates does NOT mean “creating new money out of thin air”. All Fed is doing is lowering the overnight borrowing interest rate that banks and other financial institutions charge each other, and the discount rate, which is the rate at which some privileged borrow from the ultimate feeder – the Fed itself. To create more money, Fed has to explicitly bump up the balance sheets of other financial institutions and of the Treasury itself.. Lowering of the interest rates is neither necessary nor sufficient condition in this respect…

And also – of course everyone is aware of detrimental effects of increasing the money supply. The governments print more money NOT because they are ignorant, as the author seems to allude, but simply because they can do it and they always need more. So the problem is purely political…

It’s like advocating against war by describing the potential horrors of war in minute details, telling everyone about incredible destruction and suffering that it brings about… But the wars happen NOT because the conflicting nations or governments don’t know about it. They happen because someone stands to benefit from it. The same applies to the economy as well…

fundamentalist March 2, 2009 at 6:41 pm

Stephen Grossman: “How can you integrate this with Mises’ view that interest rates are time preferences?”

Actually, there is not contradiction. Time preference is the source of interest in Mises’ “evenly rotating economy” or in equlibrium, both of which have no money because there is no uncertainty. Even without money, in a barter economy, interest exists and it’s based on time preference.

As you move to a dynamic economy with uncertainty, and money, time preference alone does not determine interest rates, but it is the starting point. Hayek wrote that time preference determines the level of savings, but not the interest rate. In addition to time preference, things like marginal productivity, risk, money supply, demand for money, demand for loans, etc. all play a role in setting market interest rates.

In short, Mises was talking about the origin of interest rates when talking about time preference, but Murphy is talking about the market rate of interest, two very different things but related.

Alex March 2, 2009 at 6:50 pm

Abhilash Nambiar:

You said, “Lending is not the same as saving. There is a fine line. You can after all save your money by keeping it under your pillow, or the secret safe behind your book case. Lending means there is interest.”

If someone spends less than their income, this saving is held either in equity form or in the form of debt instruments. Equity savings may be held in real (physical) assets (suppose you purchase equity in a home or you buy a few ounces of gold), or in common stocks, or other equity financial instruments. If you hold currency under your pillow, you are lending money to the government (the debt instrument is the currency); if you deposit the cash in the bank you are lending the money to the bank, etc. Total saving is therefore represented either by equity or lending.

Abhilash Nambiar March 2, 2009 at 7:44 pm

Alex: If you hold currency under your pillow, you are lending money to the government.

Only true in case on fractional reserve banking. Not in case of 100% reserve banking. In fact the whole financial system gets blurry, when money is not backed up by real assets.In fact this was a real problem for FDR. The gold standard was still on at that time. He actually appealed to the American people not to keep their money under the bed and put it in a bank.

Alex: Total saving is therefore represented either by equity or lending.

Again that is what the meaning of savings has evolved into, in the current fractional reserve banking regime. Actually, total saving is represented by the total quantity of commodity money kept in safe keeping for the expressed purpose of saving. I recognize of course that most savers (actually almost all) hope the money retains its value when saving.

In the current system, when you keep your money savings under your pillow and it looses value, you are not lending to the government. Can anyone lend what is theirs without being asked first? The government is stealing its value by printing new money. Is currency used here as an instrument of debt, but an instrument of theft?

I would highly recommend Rothbard’s book ‘What has the government done to our money?’


gene March 2, 2009 at 10:02 pm

That is true. If you hold money under your pillow, you are simply “storing” your product, the result of your labor. If the government is devaluing it while you store it, then they are “taking” value from you without permission which can only be theft or maybe indentured servitude, not a loan.
There is only storage or investment, which is credit/debt. Our current system uses any deception it can to allow the “privlidged” to invest other people’s money and profit from it. If this isn’t sufficient, they print money and hand it out. And as was commented, they know what is going on, they just “need” to do it and can do it. The problems occur when their fantasy economy confuses itself by remembering the real economy and then panic occurs. If they keep it in the dream world, everything works out fine for them.

mstob March 2, 2009 at 11:34 pm

Exactly what is the correlation between bonds and interest rates?

How does an increase/decrease in US bonds on the market lead to a change in interest rates?

I am keen to understand this point, asides from that it was a very interesting article.


Sally Copperwaite March 3, 2009 at 7:57 am

One serious side effect of keeping interest rates artificially low (as already discussed by Frank Shostak and others) is that it encourages ordinary people to make bad investment decisions. One example here in the UK is that people are being sucked into the property market at a time when they should be renting. Another example is the number of managers of bankrupt companies who are forming management buyouts (to protect their own jobs) because the owners don’t want to throw any more money down the drain. None of these things would be happening if credit was being priced properly. Personally, I feel that the government and the Bank of England are behaving in a criminally irresponsible way by encouraging people to take on more debt by mispricing credit.

Alex March 3, 2009 at 8:34 am


A bond is a receipt a borrower gives a lender. A greater issuance of bonds means that there is greater borrowing taking place. In order to attract more people to lend, the borrowers have to offer higher interest rates.

mstob March 3, 2009 at 8:52 am

Alex, (or anyone else who may be able to explain).

So, in order to increase the issuance of bonds, the treasury offers a higher interest rate on them, thereby increasing the amount of loans. Bonds flood the market, and in turn, those bonds are loaned out by private banks and thus that becomes the dominant interest.

This, in turn, has nothing to do with the money supply which is what happens when the federal reserve buys or sells bonds, am I correct? Federal Reserve purchases of securities has no effects on interest rates right?

Also, regarding Alex’s point, this is one thing in the article that confused me:

“On the other hand, private-sector buyers of Treasury and other bonds lose out. If they had entered the market with the intention of buying a bond yielding $10,000 in ten years, they will now have to pay a higher price because of the Fed’s muscling into the picture with its Phantom Zone checkbook.”

Exactly how do they lose out? Why do they have to pay a higher price?

Alex March 3, 2009 at 10:38 am


There are two situations to keep separate: (1) a sale of new federal government bonds to the public and (2) a the purchase of federal government bonds by the central bank.

(1) has no effect on the supply of money; (2) does affect the money supply and the amount of potential loans the banks can make.

If I buy a newly issued government bond, I pay the Treasury with a check drawn on my bank account. The Treasury deposits this check at a commercial bank it deals with. The total deposits of the banking system are thus unchanged. Only the name on the deposit has changed from mine to that of the Treasury.

In instance (1), suppose I buy a newly issued $100, 4% federal government bond for 98 (% of face value), or in other words for $98. Why won’t I or anyone else pay $100 for the bond? Because the “4%” information about the $100 bond means that 4%x$100=$4 interest will be paid by the Treasury to whoever holds the bond (to whoever is lending the money, in other words). If potential lenders want, say, 4.2% (something higher than 4%) before they would be willing to lend to the federal government (before they would be willing to buy these particular bonds) they are only willing to pay a price of, say, $98 per $100 face value bond (I am assuming at this price and for the maturity of the bond, $4 interest each year will give a 4.2% annual interest yield). Now, even though the bonds state a coupon yield of 4%, if they are issued at below face value to yield lenders 4.2%, then it is 4.2% that the government is actually paying to borrow. Each bond brings them only $98 and they have agreed to pay an annual $ interest amount of $4 for each bond.

Now assuming the federal government is issuing a lot of new bonds, in order to attract lenders funds (in order to make it attractive for lenders to buy these bonds) the government will have to pay higher interest rates than they would have had to pay if they had issued a very small amount of new bonds. Perhaps if they had only issued a small amount, the government could have borrowed the money at only 3.7% instead of 4.2%.

Other bondholders will see interest rates (interest yields) on government bonds going up, so that this reduces the attractiveness of the bonds they were holding (whether government or corporate). The prices of these other bonds are thus forced downward by the market, and thus their yields upward, until the market (bondholders) think that these yields are now appropriate.

In case (2), the Fed buys, say, $98, or $110 or $20 billion (whatever amount, but let’s deal with $98) of government bonds from the public (say, from me). I get a check drawn on the Fed and deposit it in MYBank. MYBank sends the check back to the Fed in the check clearing process. The Fed gets the check drawn on itself and informs MYBank that it has $98 more on deposit at the Fed. This amount balances the $98 extra deposit liability MYBank has to me. But the added $98 of MYBank deposits at the Fed represent cash reserves, and since MYBank doesn’t need to hold 100% cash reserves against deposits, they can increase lending. Thus there is an increase in the supply of money (commercial bank deposits) and bank loans in case (2). The increase in available bank loans means that bank loans become cheaper, that is, bank interest rates fall.

But if it is cheaper than before to borrow from banks, corporations will be willing to pay lower interest rates to borrow by issuing notes or bonds. Let’s say that $10,000 face value of bonds with a 5% coupon rate were trading in the bond market at their face value ($10,000) to yield 5% before the Fed caused an increase in the supply of money and bank credit. After the increase in bank credit causes lower interest rates throughout the financial markets, potential bond buyers will now think that the 5% yield on the above bonds is a great deal. In fact, bond buyers now may be willing to accept only 4.5% on such bonds given that their savings earn lower interest rates elsewhere now. So potential bondholders clamor for these bonds, thereby bidding their price up to say $10,500. This means that it now costs $500 more for these bonds.

I think rather than focusing on bond prices, however, focusing on yields is perhaps better. Lenders (bondholders) want the highest yield they can get on their funds and the central bank action here forces down their yields, which means that their financial wealth will grow over time at a smaller rate than otherwise.

billwald March 3, 2009 at 2:37 pm

Dr. Murphy understands the problem but the solution eludes him because he is hung up on the concept of “money” as are the people who argue about saving money (cash) under one’s pillow. 90% of the money in circulation is electronic transfer and less than 5% is cash. Cash is only useful to tax evaders, criminals, and dope sellers.

Half the US economy is under the table, illegal activity. The only people who pay their way in full are those who work for wages that are reported to the IRS.

The obvious solution is to admit that “money” is electronic transfer and a book keeping convenience. Eliminate paper money and issue coins up to ten dollars denomination so that one can buy a newspaper without using a credit card. The result is that the dope sellers will have a BIG problem and skilled workers will find it more convenient to pay income tax than to be paid a thousand dollars in ten dollar coins for a construction job.

THIS WILL NEVER HAPPEN. Why not? How will we bribe politicians without cash money?

Gerry Flaychy March 3, 2009 at 9:57 pm

“Money and Interest Are Different Things” : really ?

5% of 1000 $ = 50 $

5% is a rate, here an interest rate.

50 $ is the interest.

50 $ is money.

1- interest rate is not money;

2- but interest is money.

Frank March 7, 2009 at 4:27 am

I guess…

If SUVs were the official currency, bonds were the only way to save, and there was no such thing as borrowing, sure.

The Fed is the paper miner!

Fear not, the loansharks will be bringin the high interest rates soon enough.

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