Monetary Theory

Monetary Theory

Alan A. Rabin

Alan Rabin argues that new Keynesian and new classical macroeconomics, which have dominated the literature and textbooks, have crowded the monetary-disequilibrium hypothesis, or orthodox monetarism, off the intellectual stage. Trying to remedy this imbalance, the author concentrates on what he judges to be the essentials of monetary theory.

Chapter 10: Interest Rate Theory

Alan A. Rabin

Subjects: economics and finance, money and banking


This chapter views the interest rate, broadly interpreted, as basically a real phenomenon and addresses the following two questions. What factors determine the interest rate? What functions does it perform in a market economy? While it is convenient to speak of ‘the interest rate’ as well as of ‘the wage rate’, we recognize that in reality no single rate of either kind prevails. Yeager (1994b) cites the contributions of the following to interest rate theory: Allais (1947), Böhm-Bawerk (1959), Cassell (1903 [1956]), Eucken (1954), Fisher (1930 [1955]), Hirshleifer (1970) and Wicksell (1934). INTEREST AS A FACTOR PRICE We can simplify capital and interest theory, tie it in better with general micro theory, and clear up certain puzzles by resurrecting the view that the interest rate is the price of ‘waiting’, a factor of production. Waiting is the service performed by holding financial and physical assets instead of selling them and devoting the proceeds to current consumption or to other current exercise of command over resources. Waiting has the dimensions of value over time. We do not claim that this view of the interest rate is the only valid one. We invoke the distinction made in Chapters 1 and 9 between an approach and theory. The approach we take here is compatible with other approaches to the interest rate (for example, compare Chapter 2). A.R.J. Turgot noted over two centuries ago that the interest rate is ‘the price given for the use of a certain quantity of value during a...

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