Books / Digital Text

Part Four: Catallactics or Economics of the... > Chapter XX. Interest, Credit Expansion, and the...

1. The Problems

In the market economy in which all acts of interpersonal exchange are performed by the intermediary of money, the category of originary interest manifests itself primarily in the interest on money loans.

It has been pointed out already that in the imaginary construction of the evenly rotating economy the rate of originary interest is uniform. There prevails in the whole system only one rate of interest. The rate of interest on loans coincides with the rate of originary interest as manifested in the ration between prices of present and of future goods. We may call this rate the neutral rate of interest.

The evenly rotating economy presupposes neutral money. As money can never be neutral, special problems arise.

If the money relation--i.e., the ratio between the demand for and the supply of money for cash holding--changes, all prices of goods and services are affected. These changes, however, do not affect the prices of various goods and services at the same time and to the same extent. The resulting modifications in the wealth and income of various individuals can also alter the data determining the height of originary interest. The final state of the rate of originary interest to the establishment of which the system tends after the appearance of changes in the money relation, is no longer that final state toward which it had tended before. Thus, the driving force of money has the power to bring about lasting changes in the final rate of originary interest and neutral interest.

Then there is a second, even more momentous, problem which, of course, may also be looked upon as another aspect of the same problem. Changes in the money relation may under certain circumstances first affect the loan market rate of interest on loans, which we may call the gross money (or market) rate of interest. Can such changes in the gross money rate cause the net rate of interest included in it to deviate lastingly from the height which corresponds to the [p. 539] rate of originary interest, i.e., the difference between the valuation of present and future goods? Can events on the loan market partially or totally eliminate originary interest? No economist will hesitate to answer these questions in the negative. But then a further problem arises: How does the interplay of the market factors readjust the gross money rate to the height conditioned by the rate of originary interest?

These are great problems. These were the problems economists tried to solve in discussing banking, fiduciary media and circulation credit, credit expansion, gratuitousness or nongratuitousness of credit, the cyclical movements of trade, and all other problems of indirect exchange.