§18. A Working Concept of the Rate of Interest

While any exact and practical definition of a pure rate of interest is impossible, we may say roughly that the pure rate is the rate on loans which are practically devoid of chance. In particular, there are two chances which should thus be eliminated. One tends to raise the rate, Edition: current; Page: [35] namely, the chance of default. The other tends to lower it, namely, the chance to use the security as a substitute for ready cash. In short, we thus rule out, on the one hand, all risky loans, and, on the other, all bank deposits subject to withdrawal on demand, even if accorded some interest. We have left safe securities of fixed terms not likely to be transferred or transferred often before maturity. Such securities give us the nearest approach to pure interest both for short and long periods according to the time to maturity.

In this book, I shall usually confine the concept of the rate of interest to the rate in a (humanly speaking) safe loan, or other contract implying specific sums payable at one date or set of dates in consideration of repayment at another date or set of dates. The essentials in this concept are (1) definite and assured payments, and (2) definite and assured repayments, and (3) definite dates. The concept includes the concept of the rate realized on a safe security such as a bond purchased in the market. It is this that concerns us in this book. We are not primarily concerned with total interest, but with the rate of interest.

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