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Chapter 17: The Theory of Interest Rates
John Smithin* Introduction In discussing the treatment of interest rates in heterodox monetary analysis, there are three key issues that need to be debated/discussed before any other matters can usefully be raised. There are (1) the basic or essential nature of interest, and, speciﬁcally, whether or not it is purely a ‘monetary phenomenon’ as Keynes said, or simply the reﬂection of some other, supposedly more ‘real’, economic phenomenon, (2) the distinction between real (in the sense of inﬂation-adjusted) interest rates and nominal interest rates (in principle, this is an entirely diﬀerent issue from the ﬁrst point), and (3), the relationship between interest rates on securities with diﬀerent terms to maturity, that is between ‘short’ and ‘long’ interest rates. The ﬁrst three sections of this chapter therefore deal with each of these points in turn. There then follows a discussion of alternative theories of interest rate determination. Writers such as Hicks (1989) and Smithin (1994; 2003), for example, have previously claimed that there are fundamentally three such theories, but in this chapter it is now argued that it is more useful to think of four alternatives, the fourth (actually the most inﬂuential in orthodox circles) being a hybrid of two of the others. Finally, there must be some discussion of the thorny question of the ethics of the principle of interest on money, in the context of a capitalist-type economic system. The nature of interest Fletcher (1987, 154) highlights an important quote from Keynes to...
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