Wednesday, 19 August 2015

Today’s test: Interest rates

Today I want to offer you a short test.

Consider this quote, from celebrated Austrian economist Eugen von Bohm-Bawerk

The higher a people's intelligence and moral strength,
the lower will be the prevailing rate of
interest.

Discuss it, with reference to the interest rates of today (ZIRP), and those prevailing for nearly two centuries (see below).

Are we more rational today? Or is something else going on?

Answers in the comments, in less than 200 words please. (Readers may wish to refer both to Mises and Hayek’s discussion of “forced savings,” and George Reisman’s of the role of reason and freedom in capital accumulation.)

3 comments:

  1. Intelligent people tend to be rational (my definition of intelligent anyway, I don't consider a doctor that thinks communism is good as someone intelligent, for example). Rational people can make rational decisions about what to invest in. The lender, also being rational, knows that the borrower is rational themselves. All in all the risk is lower to both the borrower and the lender and therefore the mutually agreed interest rate is lower.

    How's that for a guess?

    ReplyDelete
  2. Intelligent people tend to be rational (my definition of intelligent anyway, I don't consider a doctor that thinks communism is good as someone intelligent, for example). Rational people can make rational decisions about what to invest in. The lender, also being rational, knows that the borrower is rational themselves. All in all the risk is lower to both the borrower and the lender and therefore the mutually agreed interest rate is lower.

    How's that for a guess?

    ReplyDelete
  3. Thanks for your comment, Daddy. Bit disappointing no-one else wanted play, but there you go.

    EBB said, "The higher a people's intelligence and moral strength, the lower will be the prevailing rate of interest." He also argued that the prevailing rate of interest, let's call it the natural rate, is set by people's time preference--i..e., by how folk value the future as against the present.
    If you have a short time horizon, then you have high time preference; if you have a long time horizon, then you have low time preference. Low time preference means you might value $105 next year slightly more than you value $100 today; high time preference means you might value $100 today more than you value $105 next year. Those two valuations form the basis of a trade--and the sum of all those trades ends up setting the "natural" interest rate--higher if folk generally have shorter time horizons; lower if they generally have longer time horizons.

    And what leads to longer time horizons? According to George Reisman, greater freedom, more well-respected and protected property rights, and a greater respect for reason and science. This generally leads to a greater degree of rationality and of certainty, and hence of longer time horizons and lower time preference. Thus: The higher a people's intelligence and moral strength, the lower will be the naturalrate of interest.

    So what happens when we have less freedom, less well-respected and protected property rights, and very little respect for reason and science--suggesting the natural interest rate should be fairly high-- AND THEN INTEREST RATES ARE SET WELL BELOW THAT NATURAL RATE?

    Well, then you begin to see the monetary problems around us today ...

    ReplyDelete

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