Wednesday, October 11, 2017

Eric Tymoigne — Money and Banking Post 21: The Interest Rate

In Post 20, a lot is said about the role that the rate of return on financial instruments—the interest rate—plays on the pricing on securities, but little was said about what determines that rate of return. Two competing theoretical frameworks explain what influences the interest rate, one of them emphasizes the role of real factors and the other emphasizes monetary factors.
New Economic Perspectives
Money and Banking Post 21: The Interest Rate
Eric Tymoigne | Associate Professor of Economics at Lewis and Clark College, Portland, Oregon; and Research Associate at the Levy Economics Institute of Bard College

6 comments:

Matt Franko said...

This is getting warmer:

"The rate of return on capital equipment is called the marginal efficiency of capital (mek) and the rate of return on lending monetary instruments is the interest rate i. If mek > i, firms issue debts to obtain monetary instruments and use the proceeds to buy capital assets. If they buy new capital assets, aggregate investment occurs. As more machines are produced, the mek falls because it becomes more difficult to sell output at a given price as markets become saturated (there is only a limited number of customers for a given product). If mek < i, firms decrease their investment level. The problem becomes to figure out what determines the interest rate."

Govt determines the rate... (isnt this guy a MMT person???)

Warren Buffet:

""If the government absolutely said interest rates are going to be zero for 50 years, the Dow would be at 100,000," Buffett told "Squawk Box," stressing he was speaking hypothetically. The Dow Jones industrial average closed at 17,773 on Friday.

In a CNBC interview last week, Buffett also spoke about interest rates. "If you had zero interest rates and you knew you were going to have them forever, stocks should sell at, you know, 100 times earnings or 200 times earnings," he said."

https://www.cnbc.com/2016/05/02/buffett-says-if-the-government-did-this-the-dow-could-hit-100k.html

See 'Risk Free Rate':

https://en.wikipedia.org/wiki/Risk-free_interest_rate

As used in the Capital Asset Pricing Model:

https://en.wikipedia.org/wiki/Capital_asset_pricing_model

Why dont the Economics dept people in the academe just walk across campus and ask the Business School people in the academe what they are training their students to do? then they would know what people are doing...

Matt Franko said...

Also, see Band Pass Filter from systems theory:

https://en.wikipedia.org/wiki/Band-pass_filter


systems can have BOTH a lower and upper cutoff setting... its not always a straight line or a divergent curve....

Warren Buffet is only talking about the lower cutoff setting (ie zero rate...)





Tom Hickey said...

Matt, there's a difference between the base the cb may chose to set or delegate the setting of as in Libor, and "the rate of return on lending monetary instruments is the interest rate I."

The money lending rate of return is influenced by the base rate but the base rate doesn't determine the money rate of lending.

The slope of the yield curve (first derivative) rises off the base rate but is variable depending on conditions and its second derivative is also variable. The yield on the 10yr bond is the base rate for figuring the prime rate, which banks use as the benchmark for lending to less qualified borrowers.

There are many interest rates. The "own rate" of the currency can be set by the monetary authority if it chooses to do so as monopolist, but there is no necessity that it do so directly. The BoE delegated Libor setting to the banks.

There are other "own rates."

“The ‘own-rate of interest’ of a commodity is defined as the ratio of a definite quantity of a commodity, say wheat, available at a future date (t+1), exchanged against a definite quantity of the same commodity at date (t).”3 Fisher (1896, pp.8ff)

Own-rates, that is to say, emerge in the course of forward trading in commodities. When a commodity, e.g. wheat, is sold forward – i.e. with price contract made at time t but delivery from seller to buyer delayed until time t+1 – the seller is in effect borrowing the commodity and pays interest (which may be positive or negative) accordingly. Note also, that the forward seller, in carrying the commodity though time, may be said to be ‘investing’ in the commodity as an asset (the yield on which depends on the extent to which the forward price exceeds the spot price). (Corresponding to the forward seller’s operation, a forward buyer is lending the commodity, agreeing at time t to delayed delivery in t+1; the lender’s return may be positive or negative depending on the relationship of the spot and forward prices.)


Roy H Grieve, An issue with own-rates: Keynes borrows from Sraffa , Sraffa criticises Keynes, and present-day commentators get hold of the wrong end of the stick

Philippe said...

Matt, government doesn't determine the real interest rate.

Matt Franko said...

Phillips I don't believe in "inflation"....

Matt Franko said...

Philippe ... sorry...