There is both a real and an apparent fluctuation in the interest rate from place to place and from time to time. The apparent fluctuation is that which is due to the inclusion of insurance against risk in a single rate with the real interest. Thus loans on good security always command a lower rate than others. This simply means that a man who takes some risks as to getting his money back adds to the pure interest a premium to cover the risk. Gross interest, then, includes the two elements of net or pure interest, payment for the loan itself, and insurance against risk of loss, or of trouble in collection. Naturally, therefore, interest tends to be higher in uncivilized countries and backward communities. Again, long-time loans usually command a slightly lower rate than short-time loans, because with such loans the lender is saved the trouble of frequent reinvestment. Aside from these conditions, moreover, a steady diminution of pure or net interest occurs in most civilized countries. This last change is due, not to lessened risk, but to the change in mental comparisons between present and future goods. Present wants, being better satisfied, are less clamorous and contrast less vividly with future wants. Moreover, providence increases with civilization. The lowering of the pure interest rate means that the great body of people are both less needy in the present and more thoughtful of the future.

Usury.The word "usury," once applied to all interest, is now applied only to interest in excess of the rate allowed by law. The question of whether laws should be framed limiting the rate to be received and fixing penalties for violation, has been much discussed. Economists are generally agreed that the State should not attempt to establish a rate, except so far as it can confine the action of the law to loans to the needy for personal consumption. One effect of usury laws is worthy of special notice. When the law has established a fixed rate, under penalties, it may happen that law-abiding people will be unwilling to make loans at the legal rate, and that those who are willing to violate the laws will thus have an added reason for charging a higher rate than they otherwise would. Competition among lenders is lessened, and the risk of loaning is increased. Both these items act in the direction of excessive rates. Though many countries have laws designed to prevent the taking of excessive interest, the commercial world, which is regulated in great measure by the honor of the business men, commonly proceeds in disregard of the law's penalties. Those who borrow at excessive rates do so willingly and knowingly, and are in honor bound not to appeal to the law to escape their just debts.

Summary

1.Interest is the reward paid for the use of capital.

2.Capital differs from land in that it is produced. Social capital consists of all producers' goods.

3.Speaking generally, interest is determined by the relation between the supply of capital and the demand for it, at a point or rate which equalizes the supply and the demand.

4.The demand for capital depends upon its productiveness, the value of its product.

5.The supply of capital depends in general upon its cost of production, i.e. upon the sacrifice involved in the abstinence of the marginal saver or investor.

6.The cost of abstinence arises from the fact that men regularly value more highly the present as compared with the future, and the cost is therefore measured by the extent of this higher valuation.

7.Capitalistic production is more productive than non-capitalistic production because it enables men to substitute indirect processes for direct ones, and thus enables men to use natural forces.

8.Long-time loans and short-time loans, while affected by different sets of conditions, tend to have the same rate of return, and this rate is also that for the loans of other goods which are not capital.

9.The interest rate, as ordinarily stated, really measures the return for risk as well as the return for capital, which is pure interest. Both gross interest and pure interest tend to fall with advancing civilization. 10. Usury, now applied to interest in excess of a legal rate, is frequently made subject to penalty. Such penalty, however, usually has the effect of raising rather than lowering real interest.

Questions

1.What are the differences between capital and land? The resemblances ?

2.What is interest? How was the taking of interest regarded in early times ?

3.What is the supply and demand theory of interest? What is the productivity theory? What element of truth does it contain? What is the abstinence theory ? What element of truth does it contain ? What is the Austrian theory ? Are these theories necessarily contradictory ?

4.State in summary form the complete theory of interest.

5.Why is it right to say that the cost of capital is abstinence? What is meant by marginal investment? How do relative valuations of present and future compare in the case of children and adults? Of children and savages ? Of rich and poor ? What relation has this to interest?

6.Show in detail the services rendered to production by capital.

7.What different loan markets are to be distinguished ? How does the interest rate in the first affect that in the second ? How is the " rent" of houses determined ?

8.What two elements are there in the ordinary interest rate ? What is pure interest ? What two reasons are there for a fall in the interest rate with advancing civilization ?

9.What is usury? What are usury laws? In what case are usury laws beneficial ?

Literature

See list of works cited at close of Chapters II and III. Also: — Böhm-Bawerk, E. von: Capital and Interest, Translator's Preface, pp. xix-xx; also Positive Theory of Capital, Bk. V, Ch. III, pp. 253-259. Clark, J. B.: The Distribution of Wealth, Ch. XII, pp. 182-187. Mill, J. S.: Principles of Political Economy, Bk. III, Ch. XXIII, §§ 2 and 4. Walker, F. A.: Political Economy, Part IV, Ch. III, pp. 218-232, and

Part VI, § 1. All standard works on Economics discuss these topics.