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5. The Computation of Interest
Originary interest is the outgrowth of valuations unceasingly fluctuating and changing. It fluctuates and changes with them. The custom of computing interest pro anno is merely commercial usage and a convenient rule of reckoning. It does not affect the height of the interest rates as determined by the market.
The activities of the entrepreneurs tend toward the establishment of a uniform rate of originary interest in the whole market economy. If there turns up in one sector of the market a margin between the prices of present goods and those of future goods which deviates from the margin prevailing in other sectors, a trend toward equalization is brought about by the striving of businessmen to enter those sectors in which this margin is higher and to avoid those in which it is lower. The final rate of originary interest is the same in all parts of the market of the evenly rotating economy.
The valuations resulting in the emergence of originary interest prefer satisfaction in a nearer period of the future to satisfaction of the same kind and extent in a remoter period of the future. Nothing would justify the assumption that this discounting of satisfaction in remoter periods progresses continuously and evenly. If we were to assume this, we would imply that the period of provision is infinite. However, the mere fact that individuals differ in their provision for future needs and that even to the most provident actor provision beyond a definite period appears supererogatory, forbids us to think of the period of provision as infinite.
The usages of the loan market must not mislead us. It is customary [p. 537] to stipulate a uniform rate of interest for the whole duration of a loan contract7 and to apply a uniform rate in computing compound interest. The real determination of interest rates is independent of these and other arithmetical devices of interest computation. If the rate of interest is unalterably fixed by contract for a period of time, intervening changes in the market rate of interest are reflected in corresponding changes in the prices paid for the principal, due allowance being made for the fact that the amount of principal to be paid back at the maturity of the loan is unalterably stipulated. It does not affect the result whether one calculates with an unchanging rate of interest and changing prices of the principal or with changing interest rates and an unchanging amount of the principal, or with changes in both magnitudes.
The terms of a loan contract are not independent of the stipulated duration of the loan. Not only because those components of the gross rate of market interest which made it deviate from the rate of originary interest are affected by differences in the duration of the loan, but also on account of factors which bring about changes in the rate of originary interest, loan contracts are valued and appraised differently according to the duration of the loan stipulated. [p. 538]
- 7. There are, of course, also deviations from this usage.