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8. Production: Entrepreneurship and Change

7. The Progressing Economy and the Pure Rate of Interest

It is clear that a feature of the progressing economy must necessarily be a fall in the pure rate of interest. We have seen that in order for more capital to be invested, there must be a fall in the pure rate of interest, reflecting general declines in time preferences. If the pure rate remains the same, this is an indication that there will be no new investment or disinvestment, that time preferences are generally stable, and that the economy is stationary. A fall in the pure rate of interest is a corollary of a drop in time preferences and a rise in gross investment. A rise in the pure rate of interest is a corollary of a rise in time preferences and net disinvestment. Hence, for the economy to keep advancing, time preferences and the pure rate of interest must continue to fall. If the pure rate of interest remains the same, capital will only just be maintained at its same real level.

Since praxeology never establishes quantitative laws, there is no way by which we can determine any sort of quantitative relation between changes in the pure rate of interest and the amount that capital will change. All we can assert is the qualitative relation.

It should be noticed what we are not saying. We are not asserting that the pure rate of interest is determined by the quantity or value of capital goods available. We are not concluding, therefore, that an increase in the quantity or value of capital goods lowers the pure rate of interest because interest is the “price of capital” (or for any other reason). On the contrary, we are asserting precisely the reverse: namely, that a lower pure rate of interest increases the quantity and value of capital goods available. The causative principle is just the other way round from what is commonly believed. The pure rate of interest, then, can change at any time and is determined by time preferences. If it is lowered, the stock of invested capital will increase; if it is raised, the stock of invested capital will fall.

That a change in the pure rate of interest has an inverse effect on the stock of capital is discovered by deduction from accepted axioms and not inferred from uncertain and complex empirical data.37 The law is not deduced, for example, by observing that the market rate of interest in backward nations is higher than in advanced nations. It is clear that this phenomenon is at least partly due to the higher entrepreneurial risk component in the backward countries and is not necessarily caused by differences in the pure rate of interest.

  • 37. It is evident that Mises’ strictures in Human Action, p. 530, apply to the doctrine that the quantity of capital determines the pure rate of interest, and not to the present argument.
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