Interest is an economic concept pertinent to any scenario where present goods are exchanged for future goods. All things being equal, humans subjectively value present goods more than a claim to identical goods in the future. It is this subjective individual time preference that explains interest. Interest is the difference between the monetary value of future goods and the monetary value of present goods. Correspondingly, the interest rate reflects the ratio of the monetary value of present goods to the monetary value of future goods.
The market rate of interest is essentially the aggregate of all the individual time preference rates of the market participants. It is the vital signal that coordinates the time preferences of consumers, producers, savers, and investors. The market interest rate indicates the amount of resources that may be devoted to the production of capital goods without frustrating current consumption based on available savings. Because capital investment requires foregoing current consumption, the interest rate signals to entrepreneurs the availability of real savings accumulated to undertake capital investment projects. In short, the interest rate is a measure of the market's preference of present goods in relation to future goods.
In our next lesson we will begin to see why artificial distortion of this signal is particularly harmful to an economy. Significant damage results when the government pursues a cheap credit policy in order to drive down the interest rate below market levels. The artificial expansion of credit has the ability to set the Boom/Bust business cycle in motion...
Two good essays for additional reference:
Böhm-Bawerk’s Critique of the Exploitation Theory of Interest - Robert Murphy
Why Do Capitalist Earn Interest Income? - Robert Murphy
The market rate of interest is essentially the aggregate of all the individual time preference rates of the market participants. It is the vital signal that coordinates the time preferences of consumers, producers, savers, and investors. The market interest rate indicates the amount of resources that may be devoted to the production of capital goods without frustrating current consumption based on available savings. Because capital investment requires foregoing current consumption, the interest rate signals to entrepreneurs the availability of real savings accumulated to undertake capital investment projects. In short, the interest rate is a measure of the market's preference of present goods in relation to future goods.
In our next lesson we will begin to see why artificial distortion of this signal is particularly harmful to an economy. Significant damage results when the government pursues a cheap credit policy in order to drive down the interest rate below market levels. The artificial expansion of credit has the ability to set the Boom/Bust business cycle in motion...
Two good essays for additional reference:
Böhm-Bawerk’s Critique of the Exploitation Theory of Interest - Robert Murphy
Why Do Capitalist Earn Interest Income? - Robert Murphy
