Interest Rates and Economic Theories

Pure Interest Rate

• Determined by individuals' time preferences, reflecting how much they prefer present vs. future satisfactions.
• Lower time preference leads to lower pure interest rate, greater investment, and longer production structure.
• Higher time preference leads to higher pure interest rate, decreased investment, and shorter production structure.

Market Interest Rates

• Reflect pure interest rate plus entrepreneurial risk and purchasing power components.
• Entrepreneurial risk creates a structure of interest rates instead of a single uniform one.
• Purchasing power components reflect changes in the dollar's value and entrepreneurs' positions relative to price changes.

The "Natural Rate"

• Initial manifestation of pure interest rate.
• Also known as the "going rate of profit."
• Reflected in loan market interest rate, determined by the prevalent profit rate.

Bank Credit Expansion

• When banks inject new money into the loan market, it lowers interest rates.
• Creates an illusion of increased saved funds for investment.
• Misleads businesses into believing they have more capital for investment than is actually available.

Investment Distortions

• Increased bank-created money leads businesses to invest in "longer processes of production," particularly in higher orders of production.
• This shift is driven by artificially low interest rates and mistaken perception of increased savings.
• Investment shifts artificially from "lower" to "higher" orders of production.

Economic Imbalance

• This shift in production caused by bank credit expansion is unsustainable, as it's not based on real savings.
• Once new money reaches factors of production (wages, rents, interest), people revert to their original consumption-investment proportions.
• Demand shifts back from higher to lower orders, revealing the malinvestment in higher orders of production.

Capital Waste

• The malinvestment in higher orders of production is liquidated, reflecting an excess of capital in those sectors.
• Bank credit creation leads to a boom-bust cycle, where artificially low interest rates distort investment patterns, leading to wasted economic resources.

Explore the concepts of pure interest rate, market interest rates, and the natural rate in this quiz. Understand how time preferences and entrepreneurial risk affect investment decisions and interest structures. Test your knowledge on how bank credit expansion influences interest rates in the economy.