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Editor Note: This is the second part of a three-part op-ed regarding money. You can check out the first installment here.
When we were figuring out what constitutes something as money, we saw how the value the baker held for maple syrup diminished when his supply of that good increased and that the value someone holds for something is subjective and unique to that individual. The hunter will, likely, always hold more value in venison than the baker no matter how much venison the hunter has, as the baker is a vegetarian and holds no value in venison. Hence, even with diminishing marginal value, a person could still hold more value in a unit of money even if they have more money than the next person.
Today I will explore what interest is and what affects the interest rate.
An interest rate is the “premium” one gets on “loans” of money. Not only banks and credit card companies loan individuals money. When individuals hold money in certain types of accounts in banks or purchase bonds they are essentially loaning their money.
There are more factors that have an effect on the rate of interest than I can hash out in an opinion column but the ones I will touch on will help to explain why there is an interest rate and were originally presented by Eugen von Böhm-Bawerk in his second volume of Capital and Interest, Positive Theory of Capital, first released in 1889. In it, he states “Present goods are, as a rule, worth more than future goods of equal quality and quantity“.
Robert P. Murphy, Ph.D, in his doctorate dissertation, has defended Böhm-Bawerk’s work but also asserted that instead of comparing “present goods” to “future goods” it should be “Present Money is, as a rule, worth more than future money of equal quality and quantity.”
Böhm-Bawark gives three causes for his statement:
Before exploring the causes Böhm-Bawark gives, it is important to again point out that individuals’ time and value preferences are subjective. Also a good, say ice, is a different good depending on the time or location that good is available. Ice in Florida is a different good than ice in Alaska as are ice in the summer and ice in the winter. Depending on where and when you are, your cardinal values change.
“It (time) is in an irreversible flux the fractions of which appear in a different perspective according to whether they are nearer to or remoter from the instant of valuation and decision” ~Ludwig Von Mises’ Human Action
Back to Böhm-Bawark’s three causes:
These three statements show why, even without taking inflation into consideration, money loaned today will, generally, reap a positive interest rate. Great so now we know why there is an interest rate. Interest is utilized, when individuals who have longer time preferences engage on the market with those who have shorter time preferences, both seeming to benefit from the exchange.
Each rate of interest is unique to each exchange, the individuals involved, each of their time preferences as well as the supply and risk of those loaning and those receiving the loans.
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Written by: Tyler Colford
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