Output and Interest Rate

4 Key excerpts on "Output and Interest Rate"

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  eBook - ePub

  Islamic Money and Banking

  Integrating Money in Capital Theory

  • Iraj Toutounchian(Author)
  • 2011(Publication Date)
  • Wiley

    (Publisher)

  Thus, even the man claimed by many to be the father of economic science failed to take the first step to remove the everlasting confusion between money and capital. The sum of money supplied to benefit from interest in the money market may, or may not, go into the “adventure” of investment. In fact, the investor seeks to maximize his/her profits (or internal rate of return, to be more precise, which is totally independent from the rate of interest) according to the way interest is customarily treated in relation to the internal rate of return on any investment project. A more fundamental point is that these economists have to provide an explanation as to why interest has to be paid in the absence of inflation and risk in the first place. An investor works within a legal framework; the “firm” which makes production possible. This is essentially and totally different and independent from buying and selling money as if money is a private good. The basic difference is that the former has all the social benefits attached to it but the latter produces harm to society.

  Like the earlier economists he was seeking to defend, Cassel also confused the two concepts by observing that: “It would be misleading to suppose that the earlier economists did not understand the difference between business profits in general and that part of them which is properly interest on capital” (Cassel 1957: 24). He further observed that “Adam Smith tells us expressly that, in his time, double interest was considered a fair rate of profit.”

  Let us straighten this out once and for all. Take a simple example where an entrepreneur uses only two factors of production: capital (K) and labor (L). He borrows a sum of money at the going rate of interest, (r), to undertake a business venture and pays the labor its going wage rate, (W). Assume also that interest charges (r.K) and the wage bill (W.L) are paid after the product is sold and from the total revenue (TR) he receives. Obviously, the entrepreneur's reward is not TR but TR – r.K – W.L which is, by definition, profits

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  eBook - ePub

  Post Keynesian Monetary Economics

  • Rousseas(Author)
  • 2016(Publication Date)
  • Routledge

    (Publisher)

  More generally, what all this adds up to is that the notion of a market-clearing equilibrium "interest" rate—whether in the old "productivity-thrift" theory, or the "bastard" Keynesian IS-LM approach, or a market-determined short-run rate—is a theoretical fiction used to provide determinate theoretical solutions within arcane models bearing no relation to the real world. In the universe of economics, interest rates are not the equilibriating force of textbooks. They are essentially a markup over competitive prime costs in a broadly conceived financial sector that is bound to exhibit an even greater concentration of economic power, especially in the banking industry, as the recent, hasty deregulation of the financial sector leads to an even higher level of bank failures, the forced merger of those that do survive with the giants of the banking industry, and the entry into the banking industry of nontraditional types of institutions. In the meantime, the impact of structurally higher and uncapped interest rates all along the liquidity spectrum on what Keynes called the sector of "Industrial Circulation" will be pronounced since interest rates in their varied manifestations will play an even more significant role than before in determining investment, profits, and the process of capital accumulation and growth in a capitalist society.

  Notes

  1. A Treatise on Money (London: Macmillan, 1930), Vol. 1, p. 243, original italics. Subsequent quotations are from Volume 1, Chapters 3 and 15.

  2. "The General Theory of Employment," Quarterly Journal of Economics, February 1937, "Alternative Theories of the Rate of Interest," Economic Journal, June 1937, and "The 'Ex Ante' Theory of the Rate of Interest," Economic Journal, December 1937.

  3. Although the basic equations are taken from Davidson's Money and the Real World, Chapter 7, they have been significantly altered and the model as a whole is sharply and substantively different from that of Davidson.

  4. See especially, J. A. Kregel, "Constraints on the Expansion of Output and Employment: Real or Monetary?" Journal of Post Keynesian Economics , Winter 1984-85.

  5. See Hyman P. Minsky, John Maynard Keynes (New York: Columbia University Press, 1975), Chs. 2 and 3.

  6. Michal Kalecki, Selected Essays on the Dynamics of the Capitalist Economy, 1939–1970 (New York: Cambridge University Press, 1971), Ch. 5.

  7. Paul Meek, U.S. Monetary Policy and Financial Markets

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  Introduction to Economics

  • John Roscoe Turner(Author)
  • 2019(Publication Date)
  • Routledge

    (Publisher)

  CHAPTER XXII INTEREST

  1. The productivity theory

  2. The interest rate unaffected by variation in production

  3. Unproductive loans

  4. The money fallacy

  5. Variation of bank interest

  6. Gross interest and net interest

  7. Time-discount

  8. Illustration

  9. Time-discount in capitalization

  10. Capitalization and interest

  11. Adjustment of interest to capitalization

  12. The present worth of a bond

  13. Money loans analogous to investments

  14. The interest rate reflects time-discount

  15. Fallacy of inversion

  16. Interest involved in simple exchanges

  17. Preference for present possession

  18. Apparent exceptions

  19. The consumption idea

  20. Reasons for differences in time-discount among persons

  21. Exercises

  1. The Productivity Theory.

  Ask the common man, "What determines the rate of interest?" He will consider this a simple common-sense question and give, with an air of confidence, one or the other of the following replies: "The rate of the productivity of capital determines interest," or "The rate of interest is determined by the supply of loanable money on the market." These replies, however, are false; they represent two of the most persistent fallacies in economics.

  One observes that the rate of return on different types of business tends to be about the same. A $50,000 store, or mill, or farm, or mine will return a net yield of $2,500. He reasons from the capital value of the agent to the money worth of the product, and concludes that the rate of interest is proportionate to the productivity of capital.

  2. The Interest Rate Unaffected by Variation in Produc- tion.

  Does the capital value of a farm determine the price of the crop, or is it the price of the crop that determines the capital value of the farm? Can you sell your crop for $1,000 because your farm is worth $20,000, or is your farm worth $20,000 because you can sell the annual crop for $1,000? The order of thought must be the reverse of that assumed by the productivity theorist. The farm produces crops, but the capital value of the farm does not determine the price of the crop; it is the price of the crop that determines the capital value of the farm.

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  The Collected Works of F. A. Hayek

  • F. A. Hayek, Lawrence H. White(Authors)
  • 2011(Publication Date)
  • University of Chicago Press

    (Publisher)

  5 To every increase in the demand for one commodity (or other type of asset) there would correspond an exactly equal decrease in the demand for another kind of commodity. That is, prices would be determined in the same way as in the imaginary barter economy. And, in particular, the demand for investment goods would be exactly equal to that part of their assets which people did not want to have in the form of consumers’ goods. The supply of funds not spent on consumers’ goods would become equal to the demand for such funds at a rate of interest corresponding to the rate of profit as determined by the given prices. There would be differences between the rates of profit people expected to earn in their own businesses and the rates of interest at which they would be willing to lend and to borrow, corresponding to the different degrees of risk. But the net rate of interest would tend to be equal to the net rate of profit. And the relative prices of the various types of goods, and therefore the price differences, would depend solely on the relation of the proportions in which people distributed their money expenditure between consumers’ goods and capital goods to the proportions in which these two types of goods were available.

  Influence of Monetary Changes on Rate of Interest

  While this would undoubtedly be the position once equilibrium had been established, it is one of the oldest facts known to economic theory that changes in the quantity of money, or changes in its ‘velocity of circulation’ (or the ‘demand for money’), will deflect the rate of interest from this equilibrium position and may keep it for considerable periods above or below the figure determined by the real factors. This fact has scarcely ever been denied by economists, and since the time of Richard Cantillon and David Hume6 it has been the subject of theoretical analysis which has been further developed in more recent times,7 particularly by Knut Wicksell and his followers.8 But it has also given rise to a recurrent scientific fashion, from John Law9 down to L. A. Hahn10 and J. M. Keynes, of regarding the rate of interest as being solely dependent on the quantity of money and the varying desires of people to keep certain balances of money in hand.

  We

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