What's so Interesting About Interest: A Historical and Theoretical Analysis of the Rate of Interest

The podcast delves into the historical and theoretical evolution of understanding the rate of interest, tracing its conceptualization from ancient condemnation by Aristotle, who viewed it as an "unnatural way to accumulate wealth," to the foundational economic theories of figures like Adam Smith, David Ricardo, and Karl Marx. It highlights the early recognition of interest as a return on capital, whether for direct lending or for enterprise, acknowledging the inherent risk involved in surrendering cash now for a greater sum later. A central debate explored is whether interest primarily serves as a reward for patience and abstinence, or if it is more fundamentally linked to technological advancement and the demand for productive capital.

The discussion meticulously distinguishes between "real factors" and "monetary factors" in determining interest rates. Real factors encompass individual preferences for present versus future consumption (patience or abstinence) and the technological constraints influencing business investment and the creation of new productive capacity. In contrast, the podcast introduces John Maynard Keynes's pivotal argument that the rate of interest is not the price of real productive capital, but rather the "price of illiquidity." This perspective posits interest as the reward for relinquishing readily accessible, liquid wealth (like cash) for less liquid but potentially more productive forms, thereby emphasizing the crucial role of money, banking, and central bank policy.

The episode navigates the unresolved debates surrounding the concept of a "natural rate of interest." The conventional view suggests that this unobservable, equilibrium-bringing number, determined by real factors such as impatience, technological capacity, and demographics, should guide central bank policy to prevent inflation. However, a contrasting perspective rejects the notion of such a "magic number," advocating instead for the interest rate as a deliberate policy tool wielded by publicly owned central banks. This alternative view proposes that interest rates should be strategically set to influence wealth distribution, facilitate credit for socially beneficial activities, and enable governments to undertake critical investments, particularly in areas like confronting climate change.

Ultimately, the podcast underscores that the discourse surrounding interest rates extends far beyond mere economic mechanics, touching upon profound distributional consequences by determining the relative incomes of creditors and debtors. It frames interest not just as an economic variable but as a powerful lever with significant societal implications, influencing capital allocation, economic stability, and the collective capacity to address grand challenges. The ongoing tension between market-determined "natural" rates and policy-driven rates reflects fundamental differences in economic philosophy and the perceived role of governmental and central bank intervention in shaping economic and social outcomes.

aristotle wrote that interest the birth of money from money is the most unnatural way to accumulate wealth

in each case a sum of cash is surrendered at one point in time on the expectation that a greater sum will be recouped in the future and in both cases there is a risk that some or all of one's money may be lost

interest thus appears to be the reward for patience or for abstinence

but others noted that in order to be patient with your wealth you first need to be wealthy the poor cannot very well choose not to spend likewise evidence of abstinence among the wealthy is hard to come by

interest it appears is the very price of time

keynes argued that the rate of interest is not the price of real productive capital it is instead the price of illiquidity

interest then is the reward for giving up this liquidity and holding wealth in less liquid but more productive forms

the rate of interest determines the relative incomes of creditors and debtors

the conventional view is that the natural rate of interest is determined by so-called real factors such as people's impatience technological capacity and demographics

instead it is argued the rate of interest is a policy tool set by publicly owned central banks and it can be set at any one of a range of levels

the rate of interest should therefore be set such as to limit the incomes of the wealthy to facilitate the flow of credit for socially useful activity and to enable governments to undertake the investment needed to confront the threat of climate change