§9. Fluctuations in Interest Rates Self-Corrective

Since the choice, for an individual, among different options, depends on the rate of interest in the manner described in Chapter VI, it is clear that a low rate favors the choice of the more ascending income streams, but also that the choice of such income streams reacts to raise the rate of interest. If, on the contrary, the rate is high, the opposite of both these propositions holds true; the high rate favors the choice of the less ascending income streams, but that choice reacts to lower the rate of interest.

Thus, if we apply these principles to repairs, renewals, and betterments, it is evident that the lower the rate of interest, the better can the owner of an automobile afford to keep it in repair, and the better can the owner of a railroad keep up its efficiency, and the same applies to all other instruments. But it is equally clear that the very attempt to improve the efficiency of instruments tends, in turn, to increase the rate of interest, for every repair means a reduction in present income for the sake Edition: current; Page: [203] of future—a shifting forward in time of the income stream—and this will cause a rise in the rate of interest. Thus, it follows that any fall in the rate of interest will tend to bring its own correction.

Again, it is evident that a choice of the more durable instruments, as compared with those less durable, will be favored by a low rate of interest, and a choice of short-lived instruments will be favored by a high rate of interest. If the rate of interest should fall, there would be a greater tendency to build stone houses as compared with wooden ones. The present value of the prospective services and disservices of stone houses as compared with wooden houses would be increased, for although stone houses are more expensive at the start, they endure longer, and their extra future uses, which constitute their advantage, will have a higher present value if the rate of interest is low than if it is high. We find, therefore, as John Rae has so well pointed out, that where the rate of interest is low, instruments are substantial and durable, and where the rate of interest is high they are unsubstantial and perishable.

We see, then, that the existence of numerous options has a regulative effect. Beyond the margin of choice there always lie untouched options ready to be exploited the instant the rate of interest falls. Among these, as Cassel75 has pointed out, are waterworks of various kinds. Not only works of stupendous size but hundreds of less conspicuous improvements are subjects of possible investment as soon as the rate of interest falls low enough to make the return upon cost equal to the rate of interest. The same is true of the improving, dredging, and deepening of harbors and rivers, the use of dikes and jetties, Edition: current; Page: [204] the construction of irrigation works for arid lands, and Boulder Dam projects.

There is still room for much improvement in our railway systems by making them more efficient and more durable, by making the roads straighter, the roadbeds more secure, the rolling stock heavier, the bridges larger and stronger, by further electrifications, and similar improvements. In a new country where the rate of interest is high, the cheapest and most primitive form of railway is first constructed. Very often it is a narrow-gauge road with many curves, costing little to construct, though much to operate. Later, when the rate of interest falls, or the traffic so increases that the rate of return on sacrifice is greater, the broad-gauge comes into use and the curves are eliminated. This is the kind of change which has been proceeding in this country with great rapidity during recent years. There is a transition from relatively small first cost and large running expenses to precisely the opposite type of plant, in which the cost is almost all initial and the expense of operation relatively insignificant.