Concept of Interest

8/19/2019 Concept of Interest

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Theory of Interest

A brief overview of modern interest

theories


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Knut Wicksell (1851-1926)Knut Wicksell (1851-1926)


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Born in Stockholm, Sweden, 1851

Son of successful !usinessmn nd

rel estte !roker

"r#hn t the $e of 15

%themtics nd &h'sics

188 *conomics

1898 Interest and Prices

1916 Swedish $o+ernment d+isor on

finncil nd !nkin$ issuesmin intellectul ri+l ws the mericn

economist r+in$ .isher

http://en.wikipedia.org/wiki/Stockholmhttp://en.wikipedia.org/wiki/Mathematicshttp://en.wikipedia.org/wiki/Physicshttp://en.wikipedia.org/wiki/Physicshttp://en.wikipedia.org/wiki/Mathematicshttp://en.wikipedia.org/wiki/Stockholm


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Interest and Prices

nturl rte of interest +s/ mone' rte of interest

rel #rofit ( r )

%&K

mone' mrket ( i )


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0umulti+e &rocess model

MPK > i I > S M rises

Demand > Supply prices rise

The demand for loans will continue accumulating, and the banking systems deposit

creation continues indefinitely ! with sa"ings ne"er really catching up# Money

supply will e$pand endogenously without limit and prices will also rise without end#


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Wht cn end this #rocess

eser+e e3uirement 0onstrint


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r+in$ .isher (186-194)r+in$ .isher (186-194)


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Born in New York, 1867Born in New York, 1867

Yale UniversityYale University• 1888: B.A.1888: B.A.

• 1891: Ph.D.1891: Ph.D.

athe!ati"s # $"ono!i"sathe!ati"s # $"ono!i"s 19%&:19%&: The Theory of Interest The Theory of Interest


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The Theory of Interest:The Theory of Interest:

As determined by the As determined by theimpatience to spend incomeimpatience to spend income

andand

opportunity to invest it.opportunity to invest it.

'n"o!e'n"o!e

(a)ital(a)ital

'nterest'nterest


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ncomencome

% sta*es:% sta*es:

• Psy"hi" in"o!e or en+oy!ent in"o!ePsy"hi" in"o!e or en+oy!ent in"o!e

• eal in"o!eeal in"o!e

• oney in"o!e or "ost o- livin*oney in"o!e or "ost o- livin*


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rel incomerel income

The Thames below WestminsterThe Thames below Westminster

about %&'%about %&'%(il on can"as )' $ '*#+ cm#(il on can"as )' $ '*#+ cm#


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%one' ncome%one' ncome


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0#itl0#itl

The "alue of any property, or rights to wealth, is its "alueThe "alue of any property, or rights to wealth, is its "alue as aas a

source of income source of income and is found by discounting that e$pectedand is found by discounting that e$pected

income- ./isher, %012, p#%)3#income- ./isher, %012, p#%)3#

the vale o- "a)ital is the )resent vale o- the -lowthe vale o- "a)ital is the )resent vale o- the -low

o- /net0 in"o!e that the asset *enerateso- /net0 in"o!e that the asset *enerates

any asset that )ro"es a -low o- in"o!e over ti!eany asset that )ro"es a -low o- in"o!e over ti!e

0#itl $oods ncome

ncome +lue0#itl +lue


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te of nterestte of nterest

"a)ital vale 2"a)ital vale 2 rate o- interestrate o- interest 3 interest3 interest

(a) the time preference people have for

consuming today versus

consumption at a later time, and

(b)the expectation that income saved

and invested today will yieldgreater income tomorrow – capital

produced today will generate

greater future production than was

required to construct the capital

IMA!I"#$"

%%&!'#I!


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ifference !etween 0lssiclifference !etween 0lssicl

economists nd r+in$ .isher economists nd r+in$ .isher

A""orin* "lassi"al e"ono!ists there are -orA""orin* "lassi"al e"ono!ists there are -orsor"es o- in"o!e:sor"es o- in"o!e:

• entent• 4a*es4a*es

• Pro-itsPro-its

• 'nterest'nterest

5isher treate interest not as a se)arate entity o-5isher treate interest not as a se)arate entity o-

in"o!e, t as sentity within ea"h o- the %in"o!e, t as sentity within ea"h o- the %

sor"es o- in"o!esor"es o- in"o!e


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"ther non-economic fctors tht"ther non-economic fctors tht

influence rte of interestinfluence rte of interest

5oresi*ht intelli*en"e5oresi*ht intelli*en"e

el-"ontrol willin*nessel-"ontrol willin*ness

aitait

;i-e $


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/isher, Ir"ing# The Nature of Capital and Income#

4ew 5ork6 The Macmillan 7ompany, %028#

(cta"o, %st edition in original green cloth# $1600#

Source6 http699www#manhattanrarebooks#com9fisher#htm

http://www.manhattanrarebooks.com/fisher.htmhttp://www.manhattanrarebooks.com/fisher.htm


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:ohn Maynard Keynes .%&&1!

%0)83


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Born in Cambridge, 1883Born in Cambridge, 1883

King's College, CambridgeKing's College, CambridgeMathematics in 1905Mathematics in 1905

Alfred Marshall and Arthur igouAlfred Marshall and Arthur igou

193!"193!" General Theory General Theory

19#$" %as made a lord19#$" %as made a lord

19##" Bretton &oods Conference19##" Bretton &oods Conference

Aril $1, 19#! assed a%a(Aril $1, 19#! assed a%a(


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General Theory General Theory

))*i+uidit(reference-*i+uidit(reference-

illi3uid ssets i3uid ssets

.inncil welth

&ealth is allocated bet%een li+uid and illi+uid assets&ealth is allocated bet%een li+uid and illi+uid assets


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) ) .hus the rate of interest at an( time, being the re%ard .hus the rate of interest at an( time, being the re%ardfor arting %ith li+uidit(, is a measure of thefor arting %ith li+uidit(, is a measure of theun%illingness of those %ho ossess mone( to art %ithun%illingness of those %ho ossess mone( to art %iththeir li+uid control o/er it .he rate of interest is not thetheir li+uid control o/er it .he rate of interest is not the)rice- %hich brings into e+uilibrium the demand for)rice- %hich brings into e+uilibrium the demand for

resources to in/est %ith the readiness to abstain fromresources to in/est %ith the readiness to abstain fromresent consumtion t is the )rice- %hich e+uilibratesresent consumtion t is the )rice- %hich e+uilibratesthe desire to hold %ealth in the form of cash %ith thethe desire to hold %ealth in the form of cash %ith thea/ailable +uantit( of cash2 %hich imlies that if thea/ailable +uantit( of cash2 %hich imlies that if therate of interest %ere lo%er,rate of interest %ere lo%er, i.e.i.e. if the re%ard for artingif the re%ard for arting%ith cash %ere diminished, the aggregate amount of%ith cash %ere diminished, the aggregate amount of

cash %hich the ublic %ould %ish to hold %ould e4ceedcash %hich the ublic %ould %ish to hold %ould e4ceedthe a/ailable sul(, and that if the rate of interest %erethe a/ailable sul(, and that if the rate of interest %ereraised, there %ould be a surlus of cash %hich no oneraised, there %ould be a surlus of cash %hich no one%ould be %illing to hold- Ke(nes, 193!6%ould be %illing to hold- Ke(nes, 193!6


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Mone( 7emand .heor(Mone( 7emand .heor(

eole hold mone( for three reasons"eole hold mone( for three reasons"

7 .ransaction Moti/e .ransaction Moti/e

7

recaution Moti/erecaution Moti/e7 eculation Moti/eeculation Moti/e ncertaint(ncertaint(

:4ectation


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;n e4ectation;n e4ectation

7 f :f : 0

Md ::


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nterest ?ate is a function of mone( demand andnterest ?ate is a function of mone( demand and

mone( sul(2 it is a monetar( factormone( sul(2 it is a monetar( factor

ii@@ ii MMdd, M, Mss66


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Sir ohn icks (19:4 - 1989)Sir ohn icks (19:4 - 1989)


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Sir ohn icksSir ohn icks

Born in 190# at &ar%ic, :nglandBorn in 190# at &ar%ic, :ngland

MathematicsMathematics

Clifton College 191$$6Clifton College 191$$6 Balliol College, ;4ford 19$$$!6Balliol College, ;4ford 19$$$!6

193" *M model193" *M model


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S-% modelS-% model

Bsed on ohn %/ Ke'nes;sBsed on ohn %/ Ke'nes;s General Theory General Theory

ll e3uili!ri in !oth commodit' nd mone' ll e3uili!ri in !oth commodit' nd mone'

mrketsmrkets


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cur/e" cur/e" Y = f Y = f ..ii33 e;uality of S and Ie;uality of S and I

*M cur/e"*M cur/e" ii


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n 198$ Dics reEected this model because althoughn 198$ Dics reEected this model because although

it is a /er( useful aaratus to understandingit is a /er( useful aaratus to understanding

Ke(nesFKe(nesF General TheoryGeneral Theory but it lacs one /er(but it lacs one /er(

essential thing that Ke(nes alread( ne%"essential thing that Ke(nes alread( ne%"

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Concept of Interest