Knut Wicksell- Influence of the Rate of Interest on Prices

8/13/2019 Knut Wicksell- Influence of the Rate of Interest on Prices

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THE INFLUENCE O F THE RA TE OF INTERES T ONPRICE S3

T _ thes is which I hu mb ly submit t o cr iticism is t his. I f,other thi ngs remaining the same , the lead ing b an ks of the wor ldwere t o low er their ra te of i nter est , sa y 1 per cent . below its

or dinary level, and kee p it so f or some year s, then the pri ces o f a llcommo dit ies wo uld r ise and rise and rise with out any limit wh at-ever; on the cont rary, if the le ading ban ks were to raise the irrate of int ere st, say 1 per cent . above its nor mal leve l, and keepit s o for s om e year s, then a ll pr ices wo uld ]_U and fall and f allwithou t any limit exc ept Zero.

Now this prop osition canno t be proved d irec tly by exper ience ,because the fact r equ ired in its hy pothe sis never hap pens.

The su pposition was that the ban ks were to lower or raisethe ir intere st, other _ l_ings remainin g Lhe s ame, but t hat , ofcour se, the b an ks n ever do; why , in deed, sh oul d they? Otherthings remainin g th e same , the ban k-ra te is sure t o remain t hesam e to o, or if, by any chan ce, e.g._ by mis tak e, it w ere a ltered,it would ver y soon co m e round to its pro per le vel. M y t hesisis, therefore, only a n abst ract stat eme nt , and somebod y, perh aps ,will as k : w hat is the use of it t hen ? B ut I vent ure t o assert

tha t it may b e of very great use all the same. Ev erybod y knowsthe stat ement of Newt on t hat, if the at tract ion of the sun w er esudd enly t o cease, t hen the pl anets w oul d leave their or bitsin the tan gent ial dir ection ; this, t oo, of cour se, i s only an a bstractprop osition, becau se the sol ar at tra ction n ever c eas es, but it ismost us eful never the les s; indeed, it is the v ery c orn er- stone ofcelestial m echanics; and in th e sa me way I believe tha t th ethesis here p ropou nded, if prov ed to be true , will turn out t obe the cor ner- st one of the m ech anics of p rices, or ra ther one ofits corn er -st ones, the influence of the su ppl y of prec ious met a ls

1 X pa per read before _ha Ec oaomi¢ Se ctio n of th e Brit ish A_eoeia_iau, 19 06.

No. 66 .--vor, . xvtI. q



_1_ THE :ECONOM IC JOUI _NA5 [JUNE

and of the dema nd for com modi ties fr om t he gold -pro du cing

cou ntr ies being the other.Bef ore going further , however, we mus t answer one m orequesti on . Our supp osition might be n ot only u nrea l as to fac ts,but ev en log ical ly impo ssible ; and then , of co ur se , its use wouldbe nil . Acc ording to t he genera l opin ion am ong econom ist s, theinteres t on money is re gula ted in the long run by the profi t oncapi ta l, whi ch in its turn is de, er mine d by t he pr odu ctivi ty andrelat ive abund ance of real capita l, or, in t he term s of m odernpoli tica l econ omy, by its ma rginal p roduct ivi ty. Thi s re ma in ingthe s ame, a s, indeed, by our sup po sition it is me ant to do , wouldit be a t a ll po ssible for the ba nks to k eep the r a te o f in teresteither hig her or lower th an its nor ma l lev el, pres cribed by thesimu ltan eou s state o f the average pr ofit o n capi ta l ?

Th is question d eserves ver y care ful c onsidera tion, an d, infact, i ts pr oper ana lysis w ill take u s a long way tow ar ds solvingthe w hole prob lem .

Int eres t on m oney an d pr ofit on capi tal ar e not the s amething, n or ar e they imme dia tely connec ted w ith ea ch ot her; ifthey were, they cou ld n ot d iffe r a t a ll, or cou ld o n ly differ acer ta in a mo un t at every time. There is no doub t some con--nectin g link between them, but t he pr oper na ture an d ext entof this connecti on is not so very ea sy to defi ne.

If we look on ly a t cr ed it tran sactions b etween in dividua ls,

wi thout any inter ference of ban ks, the con nection betw eenin terest and pr ofit indeed see ms ob vious . If by inve sting yourca pita [ in s ome indus tr ia l enter prise you can ge t , a fter due allow-anc e fo r risk, a pr ofi t o f, say , 10 per cent ., then , of cour se, youwill not len d it a t a much cheap er ra te; a nd if the borrower hasno rec ours e bu t to individu a ls in the sa me situat ion a s you, hewill not be able to get the mo ney much chea per th an tha t .

Ba t it is a very differen t thing wi th the mode r n forms o fcr edit , whi ch almost a lways impl y the medi a tion of som e ban kor pr ofe ssiona l money-lender. The b anks in th eir lending bus i-ness a re not only not limit ed by their own capi tal; they a r enot , a t least n ot immedi a tely, limi ted by any c apita l what ever;by conc entra ting i n their han ds a lmos t all p ayment s, they t hem;selves cre a te t he money re quired, or , wha t is the same thing,they a cceler at e ad l _bitum the r ap idit y of the circulati on o fmon ey. The su m borr owed to-d ay in order to buy commodi t iesis placed by the seller of the goods o n his accoun t at the samebank or some other ba nk, and can be len t t he very nex t day tosome other per son wi th the sa me effect. As the Germ an autho r,



1 9 07 ] I_F LUS _ CE O P TE E RATE OF IN T_ R_ ST ON P R[ GRS _ 15

Emil S t r u c k j ustlyaysin his we l l k n o wnsk et c ho ftheE ngli s h

mon e y ma r ket : inour d a y s de ma nd a n d s u pp lyo f mon e y h a veb ec o me a boutth e sam e thin g th e d e ma nd to a l a rg ee xt e ntc r es tingtsown su p p ly .

Im a pu ts sys temo f cr ed it h e r e allp a ymentswe re ma deby tran sfe ren c en th e b a nk books h e banks wou l db e abl e to

g r a ntat a ny mo me nt any am ount o f lo a nsat a ny how e v e rdim inu t i v e a t eof int e re s t.

But th e n wh a t b ec o mes of the c onne c tinglin k b e t wee nin teres tnd pr o fi t ?I n my o p in i ont herei s no s u c hlin k ex c e p tpr eci s e ly h e e ff e c tn pr c es h ic h woul d b e ca u sed by th e irdiffe r en ce .

Whe n i nt e r es tslo w in p ro p ortiono the ex ist i ng a t e o fprofit, and if , as I t ake it , the prices thereby rise, then, of cour se ,trade will requ ire mor e sove re ign s and ba nk-notes, an d there-fore the sums len t will no t a ll com e bac k to the bank, bu t pa rtof them will rem a in in t he boxe s and pur ses of the public; i ncon sequence, th e ban k reserve s will m elt aw ay while the a mountof their li abilitie s very lik ely has i ncrease d, which will for cethem to rai se their rate of i nte res t.

The reverse o f all t his, of cou rse , will ta ke place when th erat e of in tere st has ac cidentally become too high in p roportionto the avera ge profi t on c ap ita l. So fa r, you will e as ily remark ,my pr oposition is quite in accorda nce with well-know n facts

of the money m a rket. If it be not true, if, on the co n trar y,as Thom a s Tooke ass erted, and even R ica rdo in his ea rlierwr it ings seem s to have believe d , a low r a te of i nt erest, by c heap-en ing, as they put it, o ne of the el emen ts of p rodu ct ion, wouldlower p rices, and a high r at e of int erest ra ise them--a mostsp eciou s ar gument , resting, how ever, on the unwa rrantabl e a s-sumption th a t the remuner a tion of the othe r fac tors o f pro clucfioncould, unde r such circum stance s, rem a in the s ame --then thepoli cy of b anks mus t be the very r everse of wh at it re a lly is ; theywou ld lowe r their ra tes wh en prices were getting high a ndreserves becoming low, they would raise them in the oppositecas e.

A mor e direct proof of my thesi s is re quired, howev er, andmight be giv en in some su ch way a s th is. I f as a mer chan t Ih a vesol dmy goods to the a mount of _ I 00 a g a inst a billorpromis s oryoteof threemonths and I getitdis c ountedton c eb y a b a nk o ra billroker h e rat eofdi sc ounteing 4 p er c en t .p e r a nnu m then i n fac t I hav e re c eiv e d cas hpri cef ormygood samounting t o _99. If how e ver th e billistakenby th e

Q2



216 T HE P .C ONOMZ COU_CA L _UNE

bank at 3 per cen t., then the c ash p rice of my go ods have ipso]¢ acL orisen, if only a qua rte r of 1 per cen t. ; very li kely not e venthat, because co mpe tition pr obab ly wi ll fo r ce me to c ede part ofmy ext ra pr ofit to the buyer of t he good s. In other cases, h ow-ever, when long- term credit c omes into play, the i mm edi ate riseof prices mig ht be very mu ch grea ter than th at. I f the rate ofdi scou nt re main s low, t he i nteres t on long loan s is sure to godown too; b uild ing com panies and r ailway co mpani es wil l beable t o raise money , say at 4 per c ent. instea d of 5 per cent., andtherefo re , other things b eing the sa me, they can offe r , and b ycompetition will b e mor e or l ess compelle d t o offer for w agesand mat erials , anything up to 2 5 per cent . more than before ,4 pe r cent. on £1_5 being the sa me a s 5 p er c ent . on £100.

But, furth er-- and th is is the es sential poi nt to which I wouldca ll your spec i_ att ention--t he upw ard movement of prices,whet her great or s mall in t he fir st instance , can never cease solong a s the r ate of int erest is kept lower th an its normal ra te ,i.e., the ra te con sisten t with the then e xisting mar gin al pro -ductivity o f rea l capital. Wh en all co m modi ties hav e risen in

price, a new level o/pri ces has form ed itself which i n its turnwill ser ve as basi s for a t l ca lcu lati ons for the future, and all con-trac ts. There fore, if th e ban k-rat e now g oes up t o its nor malheight, th e leve l of pric es will not go dow n; it will simplyrem ain where i t is, th ere betng no forc es in a ctio n which couldpress it do wn; and, conseque ntly, if the ban k-rat e rernains Z owe r

than its n orm al heig h t, a new imp et us towa rds forci ng up theprices will follow, an d so on. T he oppo site of a ll this will t akeplace when the ra te of intere st has becom e too high i n propo r -tion to av era ge profit, and so in bo th eas es a differ ence betweenthe t wo r ates r emai ning, the m oveme n t, of pric es can nev er cea se,ju st a s the el ectr ic current never ce ases as lo ng as the diffe renceof ten sion b etwee n the p ole s rem ains .

The pro position that a low ra te of i nt erest will r ai se pric es,a high r ate of i nte rest l ower p r ices, is in some re spe cts anythi ngbut new; it has been stat ed mor e t han o nce, bu t a formid ableobjecti on was a lwa ys triu mph antly br ought agai nst i t in theshape of s tatis tical facts; in deed, if you co nsi der the figur es

give n , e.g., 5y Sauerbeck i n his well-k nown table s in the Journalo] _he 8tn _isL ical So cie ty, you w ill gene rally find th at h igh pr icesdo no_ correspond w t_h a low rat e of inte rest, an d vice versa ; itrather com es t he oppo site way, int erest and prices very oft enr isin g and fall in g tog et her. But this objection quite lo ses itsimpor tan ce; na y, mor e, it turns into a po sitive su pper_ of o ur



1907] r_FLU SNC S OF THE RATE OF INTKR I_ST ON PRIC BS 217

theory , as soon as we fix ou r eyes on t he re la tivity o f the con -ception of i nteres t on mon ey, i ts ne cessary con nec t ion wi thpro fit on ca pita l. The ra te of in tere st is never hi gh or low initsel f, bu t only in rela tion to th e pro fit which p eopl e can ma kewith t he money in their han ds, an d th is, of course , var ies. Ingood time s, when tra de is br isk, the r ate of profit is hi gh, and,wha t is of great co nseque nce, is gene ral ly expe cte d to r ema inhigh; in per iods of depression it is low, and expect ed to r emainlow . The ra te of in tere st on money fol lows , no doubt, thesame course , bu t no t a t on ce, not o f itself; it is , as it were,dr agged af ter th e ra te of pr ofit by the movement of prices an dthe co nsequ ent chan ges in th e s tate of ban k r eserve, cause d bythe differe nce bet ween th e two ra tes. In the meant ime this

diff erence acts on pr ices in just th e same wa y as wou ld b e thecase i f, acco r ding to our or iginal suppo sit ion, pro fit on capi talwer e to re ma in const an t, an d inte r est on money we re to r iseor fa ll spont aneou sly. In one wor d, the /n teres t on money is, inr eal ity, very o ften low wh en it seems to be h igh , a nd high whenit. seems to be l ow. This I be lieve to b e the pr ope r an swer tothe objection sta ted above, as fa r as the influen ce of cr edi t onprice s is r egar ded ; occas iona lly, o f course, as in t imes of w ildsp ecu lat ion or pan ics, t he p ro blem is comp lica ted very muchby the acti on of othe r factors, wh ich n eed n ot her o be ta ken in_cons ide ra tion .

Gran ted, then , our t heory to be tru e in the ma in or in the

ab stra ct, wha t wi ll be i ts pra ctic al con sequ ences _ t o wha t exten twould the l cad /ng money inst itu tions be abl e _o re gu late pri ces ?A s ingle ban k, of cou rse, has n o suc h po we r wha tever ; indeed,

it canno t pu t its r ates, wheth er mu ch h ighe r or m uch lower th._npr escr ibed by the s tate of the marke t; i f it did , it wou ld in th eformer case lose a ll profitab le business; in t he latt er cas e itssp eedy insolvency would b e the i nevitab le consequen ce .

Not ev en a ll the ban ks of a s ing le coun try united coul d doit in t he lon g run ; a too hi gh or too lo w rate would influen ce itsba lance of trad e, and thereby ca us e an influx or reflux of goldin the wel l-know n way, so as to force the b anks to app ly theirrat es t o the state of th e un iversa l mo ney m ar ket .

Bu t su ppo sing, as, indeed, we h ave done, that a ll the leadin gbanks of the comm ercial world were to follow the sa me cours e,then go ld could ha ve no rea son t o go to on e place more tha n toanother , a nd so the a ct ion exercised on pr ices would h ave i tssway with out any hindran ce f r om the in ternat ional movem entofm o n e y . St i ll v en t he n i t ou ld underth ep r e sent cir c u m



218 _ar_ BCO NOMICZ0 UR _.L [_ U_

stances, have it s obvio us limi ts, As I remark ed at the ou tset ,the influe nc e of cr edit or the rat e of in teres t is onl y one of th efactor s act ing on pri z_es; _he oth er is the vol ume of m etalli cmoney itself, especially, in our t im es, the sup ply of gold, andso lo ng as the gold itse lf r em ains the stan dar d of va lue , thisfa cto r e vide nt ly will take the lead in t he long run. W ere theproduct ion of gold m ate ria lly to dimi n ish while the dem an d fo rmo ney be un altered, the banks no doubt, by loweri ng their ra teof inte rest , migh t for a whil e profit ably rea ct aga inst the oth er-wise inevitable pre ssure on pric es, but o n ly for a whil e, becau se,even if the r a ther unn eoess_ry stiffnes s of pr esent bank legis-lation s could be sl ac kened, the ever-growing d emand for gol d for

indu strial purpo ses woul d gra dualIy r educe _he b an k store s, andcould o nly be checked by ra ising the price of gold-- that is, bylower ing the average mo ney pri ces.

The o ther ex treme, whic h at p resent seem s mu ch more lik elyto occur : a pletho r a of gem supply , an d th e ri se of p r ices th erebycaus ed, could no t be effectually met in any way, so lon g as freecoinage of gold exists J

On _he o ther hand , ff _hi s most essen tia l step on the wa y toa rat iona l mo neta ry system should be ta ken, i f th e fre e coi ning

• of golds like th at of silver , should cea se, and even tually t he ba nk-note itself, or ra ther the u nity in whi ch the ac coun ts of ban ks

are ke pt, should become the stan dard of value, the n, and n ot

till the n , the problem of k eeping the value of mo ney st ead y, the

i It i s no t eas y t,ode scr ibe or irnJ gine the exact man ner in which a n ezce_ o rdeficienc yin the ordi narygold suppl y affects pr icme,alth ough its u ltim a te effec t onthem c anno t well be d oubte d. As in our d ays the new g oldg ener allyfindsi ts wayas scm u_ po ssible t o th_ ban ks, the common impressionseems to b e that it by somuc h in cr eas esthe l oan _blefunds o_ t he han kssand ther efo re in the fir sti nstancecauses Eae rat e of int er est to go down . This, no dou bt , would be tr ue if the n ewgoldi n its to_alit ywered epos ited by it _own er s as_v/t_l forl end ingpurp o_, an dinsofa r a s this may be t he case it indeed affor dsa n illu str ation ,and th e only pr &ctie Mone, of t he lo wering o_bankr &t_e iteoting a ri se of p ri _ea.But mos tty,I sup pos e,thegoldc omes to u_ not as len ding capita l,but a s pay ment for the imp or ts of t he g old-pr odu cin gcountries ,and i f so it s act ing o n th e pr iceswi lt he much m ore imm edia teand its effectou the r ate of interest verys light. It is even possi ble t hat the riseo fprice s, ca used by th_ increa_ cdde mand for commod ities from th e goldcoun tri es,will f_ the arriv ingof the aci d, th e necessary medium of e xcha ng ebei ngin themeanti me suppliedb y an e xt ans ion of the cre dit, so th at th e rate o f/nter est perh apswill ri se fr om th e beginn ing . In any case th e u/J£ _ts s heet o f aa i ncreased gol dstrpplywill b e a r/ze, not a fal l, in the rat _ of int er est (and v/r e v_tta with a lack ingsu pply of gold},becauset he lar gem iningent er pri sesan dthe buyingu p ofgold by t henon.pr oducingco untri es have actua lly d _tr oyadlarg e amoun tsof r eal cap ita l an dther ebygive n the rate of pr ofita tendency bori se. Thi s al l may be the e x p l _ tm ti ouof somer ather perp lexin gf eat ure s in e conom ich istory, &ri se of pr ices even when&ppar entl yca used by _ surplus of go l d upp ly very seldom bei ng amcompa_ iedby alow ra t_ of i n ter est, bu t gene r allyb y a high o ne.





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Knut Wicksell- Influence of the Rate of Interest on Prices