Thursday, April 06, 2006

What is the Pure Rate of Interest?

The ideal is purity. Is it attainable? Is it understood?

To answer these two questions as it pertains to the pure interest rate the answers are: "Not really" and "Hardly," respectively!

The pure interest rate underlies the market interest rate. The market interest rate includes risk, intervention effects, and the impact of these on the cultural time preference. Eliminating intervention and its impact on risk and its impact on the cultural time preference leads to a fairly close approach to the pure interest rate.

Most people see a number that represents the interest rate, and that is all they care about. It is unfortunate but true that there are two layers that have to be removed before most people can see beyond the numbers. First, the interest rate is a price and it serves as a means of communicating about the availability of savings. Monetary intervention is like lying since it communicates the wrong information.

Second, the interest rate is a vital link between the present and the future and so it greatly ameliorates the inherent uncertainty. Without this link functioning well, uncertainty increases. Intervention expands and intensifies uncertainty.

What the pure interest rate represents is an ideal that clearly shows the extremely harmful effects of intervention. In contrast to interventionism the pure interest rate conveys trustworthiness and advances the economy in accordance with peoples' time preference.

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