§8. The Rate of Interest

The bridge or link between income and capital is the rate of interest. We may define the rate of interest as the per cent of premium paid on money at one date in terms of money to be in hand one year later. Theoretically, of course, we may substitute for money in this statement wheat or any other sort of goods. This will be discussed in Chapter II. But practically, it is only money which is traded as between present and future. Hence, the rate of interest is sometimes called the price of money; and the market in which present and future money are traded for that price, or premium, is called the money market. If $100 today will exchange for $105 to be received one year hence, the premium on present money in terms of future money is $5 and this, as a percentage of the $100, or the rate of interest, is five per cent. That is to say, the price of today's money in terms of next year's money is five per cent above par. It should always be remembered that interest and the rate of interest are not identical. Interest is computed by multiplying capital value by the rate of interest.

The aim of this book is to show how the rate of interest is caused or determined. Some writers have chosen, for Edition: current; Page: [14] purposes of exposition, to postulate two questions involved in the theory of the rate of interest, viz., (1) why any rate of interest exists and (2) how the rate of interest is determined. This second question, however, embraces also the first, since to explain how the rate of interest is determined involves the question of whether the rate can or cannot be zero, i.e., whether a positive rate of interest must necessarily exist.