Prosperity and Depression.pdf

Chap. 3 The Over-investment Theories 37price level. A low interest level tends to raise prices and a highlevel to depress them ; but, on the other hand, rising prices tendto raise interest rates and falling prices to reduce them. If pricesrise and people expect them to continue to rise, they become moreeager, to borrow and the demand for credit becomes stronger.Falling prices have the contrary effect. Rising prices are equivalentto a premium for borrowers, falling prices are a tax on borrowers.Professor IRVING FISHER distinguishes between the "nominalor money rate of interest" and the " real rate of interest ".1 Thefirst is the rate as we find it in the market: the second is the moneyrate corrected for changes in the value of money in terms of goodsand services. Thus, ifprices rise by 30/0 during the year, a nominalrate of S% is 'equivalent toa real rate of(approximately) 2~0, becausethe purchasing power of the capital sum falls by 3%~ If pricesrise by (say) 10% a year, a nominal rate of less than 100/0 becomesequivalent to a negative real rate, because the creditor loses, interms of real purchasing power, more on the capital than hereceives as interest. Ifprices fall by (say) 10% annually, a moneyrate of 5~'~ becomes equivalent to a real rate of about 150/0.Mr. HA~y proposes the term" profit rate" for true profitsof business, which he describes as being the ratio of labour savedper annum by the capital actually in use to labour expended onfirst cost, corrected for price changes.aDemandand.rupplJ ofloanablefunds.The most convenient way of approach to theunderstanding of these rather complicated interrelationshipsis to conceive of the situation interms of the supply of, and demand for, credit.The supplyis furnished by the savings ofindividualsand corporations, supplemented by inflationarybank credits. The ability of the banks to createcredit makes the total supply more elastic than it would otherwise! See the latest version of his theory in The Theory 01 Interest, NewYork, 1930, Chapter II. The first version was contained in his Appreciationand Interest (1896). Ct. also Adarkar, " Fisher's Real Rate Doctrine"in EcoflOlnic Journal, Vol. 44, 1934, page 337, and Professor D. H.Robertson, " Industrial Fluctuations and the Natural Rate of Interest ",ibid., pages 650 et seq.• As Professor Hansen has pointed out, many of these concepts mustbe interpreted as referring to U expected," rather than to II contemporary"