Irving Fisher (1907); The Rate of Interest: Its Nature, Determination and Relation to Economic Phenomenon; The Macmillan Company, New York
Irving Fisher has argued that the rate of interest in any community is an index of the preference of the present income over that of the future income. He provided extensive historical evidence and statistical data in support of his theory. However, he first demolished other theories about rates and the rate of interest, which he termed crude and superficial. He says that certain ideas, such as the following, must first be eradicated before a correct theory of interest can be promoted.
· It is a price paid for the use of money;
· It represents the fecundity of plants and animals;
· It represents some cost to the production, such as the cost of a capitalist’s personal exertion in controlling capital;
· It is the cost of waiting;
· It constitutes a species of legalised plunder perpetuated by the employer on the employed.
Interest-taking between Jews was forbidden by Mosaic laws. Similarly, in Rome, interest-taking between Romans was forbidden. It was argued against interest that it constituted a payment for time, and that time was a gift of the Creator to which all have natural rights. Irving Fisher has argued against this idea of interest being a payment for time and thereby unlawful. He expressed this in his other writings too.
There are basically two types of interest: Explicit and Implicit. The income which a lender obtains through a loan contract may be called Explicit Interest, while the income that capital earns may be called Implicit Interest.
Socialists argue that interest ought to go to the labourers who produce capital, but capitalists rob them of it. This exploitation theory of interest is based on two propositions: first, that the values of any product usually exceed its cost of production; and secondly, that the value of any product ought to be exactly equal to its cost of production. The first of these propositions is true, but the second is false.
The cost theories of interest may be summed up as under:
· Those which regard interest as in some cases as cost; and
· Those which regard interest as surplus above a cost.
What does cost imply?
· Cost of producing;
· Cost of managing, organising or investing;
· Cost of waiting;
· Cost of abstinence; or
· Labour of saving
Bom Bawerk’s Theory
It is also called the ‘agio theory’ of interest, since it finds the essence of the rate of interest in the agio or premium or present goods when exchanged for future goods.
Bom Bawerk distinguishes two problems: (1) Why does interest exist? (2) What determines any particular rate of interest?
The answer to the first question is that this world is so constituted that most of us prefer present goods to future goods.
Rate of interest is the rate of foreseen appreciation or depreciation of each good…. However, the foreseen appreciation or depreciation of each good (e.g., gold and wheat) may not be the same…. So, it is a matter of indifference between the two items (say, gold and wheat) adopted in the contract, as the resulting quantum of debt in monetary terms will be different in both assumptions. In both cases, gold and wheat function as ‘standards’, not ‘medium’ (of exchange) …. The possibility of a zero or negative rate of interest is not feasible because the lender will hoard money without any loss to himself.
A distinction between the rate of interest in money and that in gold needs to be understood. The rate of interest in money is ‘normal’ and that in goods is ‘real’. “There are, therefore, just as many rates in goods as there are forms of goods.” The solution lies in adopting money as the standard for the rate of interest.
The “perspective undervaluation of the future”, i.e., the “time preference” is the central fact in the theory of interest. It is the preference of early income over late income …. It is the preference of early enjoyable income over late enjoyable income.
There are three periods in a person’s life when a man’s time preference is relatively high: (1) in early life, it is high because of youthful recklessness; (2) in the preparatory stage, because future income seems relatively abundant; and (3) late in life, because future income seems relatively superfluous.
The rate of interest is always based upon expectations, however little it may be justified by realisation.