Chapter 10: Interest Rate Theory
Rabin 03 chap09 2/15/04 3:46 PM Page 267 10. Interest rate theory 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 ), Eucken (1954), Fisher (1930 ), 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...
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