The Natural Rate of Interest
Fred Foldvary
[Reprinted from a LandTheory online discussion, May
15, 1999]
The Austrian economist Eugen von BohmBawerk refuted the
fructification and reproductive theories of interest held by Henry
George and others.
BohmBawerk argued that if the interest rate were zero, then seeds
would sell for as much as grown plants (minus the labor needed to grow
them). If grown plants had a higher price, it would be profitable to
buy the seeds, so the price of seeds would be bid up until the profit
was gone. So the greater value of grown plants over seeds does not
determine the rate of interest, since the effect would be rather to
bid up the price of seeds.
Alas, BohmBawerk omitted the landrent cost of moving through time.
When you work out the math, if the interest rate, "i", falls
to zero, it raises land rent, which is also part of the cost of
passing through time, so the price of seeds does not rise to equal the
harvest value of timber (which would be absurd, obviously). Foresters
had already worked this out, in what was and is called the "Faustmann
Formula." Glad to supply details, or refer you to my monograph,
Concepts of Financial Maturity of Timber.
Austrian economists instead presented the timepreference theory of
interest, in which it is the preference for presentday goods over
future goods that creates a discount in the future, which is the rate
of interest. This became accepted by mainstream theory, to some
degree, as expressed by Irving Fisher in his landmark work, The Theory
of Interest (1930). George at least recognized that pure interest has
to do with time, and that it is a natural market phenomenon and not a
problem.
The Austrian Response
The Austrian economist Eugen von BohmBawerk refuted the
fructification and reproductive theories of interest held by Henry
George and others. BohmBawerk argued that if the interest rate were
zero, then seeds would sell for as much as grown plants (minus the
labor needed to grow them). If grown plants had a higher price, it
would be profitable to buy the seeds, so the price of seeds would be
bid up until the profit was gone. So the greater value of grown plants
over seeds does not determine the rate of interest, since the effect
would be rather to bid up the price of seeds.
Alas, BohmBawerk omitted the landrent cost of moving through time.
When you work out the math, if the interest rate, "i", falls
to zero, it raises land rent, which is also part of the cost of
passing through time, so the price of seeds does not rise to equal the
harvest value of timber (which would be absurd, obviously). Foresters
had already worked this out, in what was and is called the "Faustmann
Formula." Glad to supply details, or refer you to my monograph,
Concepts of Financial Maturity of Timber.
Austrian economists instead presented the timepreference theory of
interest, in which it is the preference for presentday goods over
future goods that creates a discount in the future, which is the rate
of interest. This became accepted by mainstream theory, to some
degree, as expressed by Irving Fisher in his landmark work, The Theory
of Interest (1930). George at least recognized that pure interest has
to do with time, and that it is a natural market phenomenon and not a
problem.
