§8. Empirical and Institutional Influences on Interest Rates

The problem of fully determining any specific market rate of interest is an intricate and baffling problem to solve just as is the problem of fully explaining any historical fact whatsoever. This volume makes no claim to being the monumental work necessary to analyze every possible influence that acts upon such a rate. The purpose of the book is rather to isolate the fundamental or basic forces which are operative in the interest problem.

The approach is theoretical, rational, or philosophic, if Edition: current; Page: [488] you like, as contrasted with the statistical, empirical, or quantitative approach. While it is true that in the discussion of the theoretical portions of the book, empirical evidence has been employed, this analysis is supplemental to rather than independent of the principles to be illustrated or tested.

The aim in view has therefore dictated the suppression of the innumerable secondary factors in order to focus the analysis upon the primary factors involved. It is these latter factors with which pure economic theory is concerned and this book is intended to be a study in pure theory.

As such, its ultimate objective is to explain how the rate of interest would be determined in vacuo or under the ideal operation of the assumptions. Outside this domain, there are literally thousands of forces which would have to be analyzed and allowed for before an adequate explanation of an actual market rate of interest could be made.

Thus, after presenting in Chapter II the theoretical relations of changes in the value of money to the rate of interest, we assume thereafter (until we reach Chapter XIX) a constant value of money and therefore the absence of any influence of a changing value of money. Yet we know that such an assumption is seldom realised in this actual world of incessant inflation and deflation.

Although this methodology of pure theory is at one with that employed in the whole range of scientific investigation, it may seem to some open to the criticism of being unreal and therefore presumably defective, if not useless, so far as practical affairs go.114 While it is impossible, Edition: current; Page: [489] because of the divergent approaches, to express succinctly the criticisms which revolve about this point, certain examples may be given to set forth their general content and character.

Professor Thorstein Veblen, for example, asserted that interest did not come into existence until a high state of development had been reached in business and in money economy and credit economy. He argued that credit economy giving rise to interest economy has existed for "only a relatively brief phase of civilization that has been preceded by thousands of years of cultural growth during which the existence of such a thing as interest was never suspected" (p. 299).

"In short", Professor Veblen continued, "interest is a business proposition and is to be explained only in terms of business, not in terms of livelihood as Mr. Fisher aims to do" (p. 299). He admitted that business may be the chief or sole method of getting a livelihood, but asserted that business gains are not convertible with the sensations of consumption, as he thought my theory requires (pp. 299 and 300). Any argument for convertibility, or equivalence, is fallacious because "habitual modes of activity and relations have grown up and have by convention settled into a fabric of institutions" (p. 300).

If, at the start, we grant the postulate that the market rate of interest as set on money loans under a money economy or credit economy is the only interest rate existent, we are confronted with the problem of explaining why such a rate of interest exists. Institutions of themselves Edition: current; Page: [490] do not explain it. Institutions and conventions, like business, have been created by men, not from some inexplicable purpose unconnected with their living and feeling, but in order to add to the gratifications they obtain from living. Institutions cannot make men act or think other than as men. These man-made, man-operated institutions are merely tools devised by man to create for him gratifications more readily and more abundantly.

In my analysis, I find man's impatience to enjoy today and his desire to grasp the opportunities to invest so as to provide future enjoyments the fundamental causes which account for the emergence of incomes and of interest. To start with business institutions and attempt to explain the existence of interest as a phenomenon created by banks is like trying to explain value as something created by produce markets and stock exchanges.

Impatience and opportunity are working themselves out in the activities of business institutions, and men cannot avoid the dominance of these impulses and situations when engaged in any activity that demands a choice between present and future income. Interest, therefore, cannot be restricted to an explicit or contractual phenomenon but must be inherent in all buying and selling, and in all transactions and human activities which involve the present and the future.

While I cannot accept the view which would cast overboard theory because it is theory, I am keenly aware of the fact that theory as such does not tell the whole story about an actual rate of interest. Pure theory is not called upon so to do.

But after pure theory has said its last word, there is a broad field for empirical study of omitted factors. While we assumed that the unstable dollar remained stable and Edition: current; Page: [491] worked no interference with the fundamental forces determining the rate of interest, we know that in actual fact, the interference of a changing money value with these forces is tremendous—because of the "money illusion."

Laws, gold movements, stock exchange speculation, banking customs and policies, governmental finance, corporation practice, investment trusts and many other factors work their influences on the so-called money market where interest rates are determined. Practically, these matters are of equal importance with fundamental theory. While theory, in other words, assumes a waveless sea, actual, practical life represents a choppy one.