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|383||THE “IMPATIENCE THEORY„ OF INTEREST|
becomes less and less valuable. If prices are rising 1 per cent a year then the falling principal of the debt would have to be eked out each year by an indemnity of about 1 per cent in order that there should be exactly the same burden on the borrower in paying back as there would have been if prices had not risen. In practice this indemnity may be paid as 1 per cent higher interest. Likewise, if prices are rising 2 per cent per annum, 2 per cent would have to be added to the rate of interest, and so on. On the other hand, if prices are falling, the rate of interest, in order to offset the appreciation of the principal, would have to [d]be reduced.
A study of the periods of rising and falling prices in the United States, England, Germany, France, China, Japan, and India verifies these principles. It shows that, in general, when prices are rising, the rate of interest is high, and that in general when prices are falling, the rate of interest is low.
II. Previous Theories of Interest.
We have considered the relation of the relative abundance of money to the rate of interest. We saw that the money supply has no effect on the rate of interest except during transition periods. But the real riddle of interest still remains unsolved. Why is there such a thing as a rate of interest, even when the purchasing power of money is constant, and what determines that rate?
Many theories have been proposed. One of the most persistent is the theory that « interest is due to the productivity of capital ». If a man who has never thought on the subject is asked why the rate of interest is 5 per cent, he will almost invariably answer: « Because 5 per cent is what investments pay ». Now it is true that if you have 100 dollars and invest it, and it yields you 5 per cent a year, the rate of interest is 5 per cent. A 100,000 dollars mill will produce a net income of 5000 a year. A 100,000 dollars piece of land will produce a net crop worth 5000 a year, and so on throughout the whole series of investments. When the rate of interest is 5 per cent, nothing at first sight seems more obvious than that it is 5 per cent because capital yields 5 per cent. Since capital is productive, it seems self-evident