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Bernard M -- Taipei English Tutor

Bernard M - English Conversation / TOEFL / IELTS 一對一英文會話

Thursday, December 13, 2007

Interest Rates

With all the talk about interest rate cuts, I thought it might be useful to think about what exactly the interest rate is. Below is the the Austrian School's "correct" answer to question #3 of the Mises Quiz. It makes sense to me but keep in mind this definition is not uncontested. Note the conclusion (emphasis added).

3. What is the reason for the interest rate, and should it be regulated?

Interest payments reflect the higher value of present goods over future goods. Other things equal, everyone wants to consume sooner rather than later. The current price of a computer might be $1,000, but the price of a claim to a computer delivered in one year would currently sell for less than that, say $900. An entrepreneur might invest $900 in labor and raw materials in order to sell a product next year for $1,000; his implicit interest return is due to the fact that the factors of production represent technological "claims" on future consumption goods, and thus their current price (the $900) is less than their ultimate sale price ($1,000). Obviously the government [i.e., The Federal Reserve and other Central Banks] need not interfere with the market interest rate, since it merely reflects the subjective premium individuals place on a marginal present good over a marginal future good.

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