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270 Monetary theory

a role in intermediating the consumers demands for waiting embodied in the


final goods back to the ultimate suppliers of waiting, which could be the firms
owners. Links in a chain of intermediation involve both demanding and supplying
waiting. Intermediation and arbitrage in waiting are closely related activities.

BYPASSING UNNECESSARY DISTINCTIONS

The concept of waiting permits bypassing some distracting and often irrelevant
questions associated with a physical conception of capital. For example, what
types of goods plant and equipment, inventories of consumer goods and other
goods in the hands of producers, durable and nondurable goods in the hands of
consumers and improved and unimproved land should and should not count
as capital? Because of such puzzles about classification and for other reasons,
the concept of an aggregate of physical capital is inherently fuzzy. Some capital
goods are always being worn out and scrapped, and new and different ones are
always being constructed. Whether the aggregate is growing or shrinking or
staying unchanged may be hard to say, especially since unforeseen changes in
technology and tastes are always occurring and raising or lowering the market
values and the genuine usefulness of particular capital goods.3
Nobody conducts transactions in the aggregate of capital goods, and the
prices at which individual capital goods are bought and sold are quite distinct
from the interest rate. Waiting for value over time is something more nearly
homogeneous than physical capital. It commands a price of the same nature
whether it is devoted to fresh accumulation or mere maintenance of physical
capital or is used in other ways. In several contexts then, the concept of waiting
spares us from trying to distinguish between capital goods and other goods,
gross and net production, maintenance and accumulation, and gross and net
saving and investment. Those distinctions are vital in dealing with some
questions, but they are irrelevant distractions in dealing with some central
questions of the nature and functions of the interest rate.
A person can perform waiting and so promote the maintenance or accumu-
lation of physical capital even by just continuing to own a capital good or plot
of land or other asset instead of selling it and spending the proceeds on current
consumption. The rate of return or interest rate he receives is expressed by the
relation between the value of the services of the asset, net of depreciation and
the like, and the value of the asset itself.
One might object that the asset will continue to exist whether or not its current
owner sells it and spends the proceeds on consumption. How, then, does his
continuing to own it promote maintenance or accumulation of physical capital?
Most obviously, the owner is not engaging in consumption that he might have
engaged in and is not bidding resources away, as he might have done, from
Interest rate theory 271

maintenance or accumulation of physical capital. His selling the asset would


tend to depress the prices of it and competing assets, raising their MERs and
tempting people desiring such assets to buy them rather than construct them
afresh. One complication involves land. Its owner promotes accumulation of
physical capital by holding it. However, the demand for land as a hedge in times
of inflation represents some diversion of peoples propensity to save and
accumulate wealth away from construction of capital goods or from the purchase
of bonds issued to finance them (see pages 21920 above).
The recommended view of the interest rate as the price of waiting in no way
entails slipping into the sort of mysticism attributed to J.B. Clark and Frank
Knight and criticized by Hayek (1936 [1946], pp. 35583, especially p. 377;
1941, pp. 5, 934, 2667), among others. We need not conceive of waiting as
a sort of abstract homogeneous quantity or fund enduring through time and
embodying itself in a changing assortment of physical capital goods. People
supply waiting by refraining from currently consuming their entire incomes
and wealth and by making loans, owning capital goods and doing other quite
unmysterious things. So doing, they contribute by and large to the maintenance
or accumulation of physical capital.
The concept of waiting has the further merit of helping us avoid overem-
phasis on physical capital formation. Waiting can be productively employed
in largely nonmaterial ways, as in the training of human beings and in research.
Like other factors, too, some waiting is devoted directly to consumption:
consumer loans are analogous to labor in domestic service and to land
maintained for pleasure as gardens or wilderness.

INTERNATIONAL MOVEMENTS OF CAPITAL AND GOODS

International capital movements pose another test of alternative conceptual-


izations. Capital movements are not shipments of capital goods in particular.
People in the lending country are giving up and people in the borrowing country
are acquiring something more abstract current command over goods or
resources in general. Through the processes of overall balance-of-payments
adjustment, imbalance on capital account tends to be matched by opposite
imbalance on current account; the financial side of the capital movement
develops its real counterpart. While in general the borrowing country increases
its imports and reduces its exports, with opposite changes occuring in the trade
of the lending country, this is not necessary. In an extreme case the borrowing
country might develop a net inflow of goods and services entirely by reduction
of its exports. The real transfer could take place even if no capital goods and
no tangible goods were traded internationally; the borrowing country could
experience a rise in imports or fall in exports of services. In all such cases, nev-
272 Monetary theory

ertheless, the lenders are waiting to exercise command over real resources, and
the borrowers are obtaining advanced command over them.
The conception of capital as waiting also integrates smoothly with the theory
of how under certain conditions international trade tends to equalize the prices
in different countries of the factors of production embodied in the goods
traded. Consider new wine and matured wine produced with relatively little
and relatively much waiting. If waiting is relatively scarce and the interest rate
relatively high in the home country, matured wine commands a correspond-
ingly large price premium over new wine in the absence of trade. Abroad, where
waiting is relatively abundant and cheap, matured wine commands only a
relatively small price premium. Now trade opens up. The home country imports
high-waiting-content matured wine and exports low-waiting-content new wine
(or vodka or other low-waiting-content goods). Trade tends to equalize product
prices, reducing the price premium of matured over new wine in the home
country and shrinking production of matured wine there. Waiting formerly
devoted to the maturing of wine is freed for other uses. Trade lessens the
effective scarcity of waiting and so reduces the home interest rate.4 The opposite
occurs abroad.
The interest-equalization tendency does not depend on whether waiting enters
directly or only indirectly into production functions of goods. Perhaps waiting
enters directly into the production of widgets, which like wine require time to
mature. Alternatively, widgets are manufactured with machines that embody
much waiting. Still another possibility is that widgets are made by specialists
who must undergo years of expensive training. What difference does any of
this make for the interest-equalization tendency? Suppose widgets are expensive
because their costs include high salaries corresponding to the expensive waiting
invested in training technicians. Now international trade brings imports of cheap
foreign widgets, shrinking the domestic industry. Waiting formerly devoted to
training technicians becomes free for other purposes and as in the wine example
the interest rate falls.

NEGATIVE INTEREST

The concept of waiting helps make the unreal but instructive case of a negative
interest rate conceivable. That possibility shows by the way that waiting need
not imply irksomeness and that time preference the IRD in terms of Chapter
2 need not necessarily be positive at the margin.5 We consider an isolated
community where all goods produced are perishable, where no money and no
equity securities exist, where land is either superabundant and free or else not
subject to private ownership, and where there is no collectively organized or
family-centered social security system. We assume a stable population of
Interest rate theory 273

uniform age distribution and abstract from any differences in peoples tastes,
including time preferences, at corresponding periods of their lives. People differ
only in belonging to different generations. Each persons total production and
earnings are the same, furthermore, in both working periods of his life. So strict
an assumption is not really necessary, but it is convenient in helping to rule out
a positive rate of interest, as serves our purpose in this section.
How can anyone provide for his old age? Retired people cannot live by
borrowing because they would be in no position to promise repayment. With
accumulation of wealth in other forms ruled out, the only way to store up
command over goods to be consumed later is to acquire claims on borrowers.
(In the absence of money, loans are expressed in particular commodities or in
composite baskets of commodities.) At a zero interest rate the typical person
wants a nearly even distribution of consumption over his lifetime. He wants to
make loans in each of his two working periods and to receive repayments in
retirement. With all people having preferences of this sort, however, desired
lending would exceed desired borrowing. Only a negative interest rate can clear
the loan market. The rate must be negative in order to persuade people to depart
from their otherwise preferred more equal distribution of consumption over
their adult lifetimes. Only a reward for borrowing would persuade people to
consume especially heavily in their early working years. People in their late
working years are willing to pay young people to take loans from them so that
they can live on the repayments in retirement.
The typical person must borrow goods in his early working years, both repay
this borrowing and lend goods in his later working years, and receive repayment
when retired. In his early working years he must consume in excess of his
current income, and in his later working years he must consume an amount that
falls short of his current income by more than his earlier excess consumption.
In retirement he consumes only the repayments of loans he made in his late
working years.6
All this is easy to say in terms of waiting. Prospects of old age make people
want to postpone consumption of part of their current incomes. Yet they are
able to wait by making loans only if younger people accommodate them by
borrowing. The desired supply of waiting by lenders exceeds the volume
demanded by borrowers at a zero interest rate. Clearing the market requires
that waiting be penalized and accommodating it rewarded.
Considering the odd conditions necessary for a negative interest rate helps
us see, by contrast, why the interest rate is almost always positive in the real
world.7 Among its other features our imaginary economy lacks storable goods,
money and scarce privately ownable land. The perishability of all goods implies
that waiting has negative marginal productivity.
Just as a negative price of waiting is conceivable, so are a negative marginal
productivity and a negative wage rate of labor in a particular occupation. The
274 Monetary theory

occupation might be particularly enjoyable or afford particularly valuable


training, and workers in it might live on wealth from other sources. Employers
would tolerate counterproductive overcrowding if paid to do so, that is if the
wage were negative. Our purpose is not to dwell on these odd cases but only
to point out that the supply-and-demand theories of the prices of waiting and
of labor apply even to them, and in parallel ways.

DERIVED DEMAND AND PRODUCTIVITY

A more general argument for the concept of waiting is that it enlists supply-
and-demand analysis as illustrated in the preceding section. In considering what
determines the price of waiting, we can explore as we do for other factors of
production what accounts for the supply and for the demand. On the demand
side we can examine why people will pay to avoid waiting and gain advanced
availability of command over resources. On the supply side we can examine
why in general and at the margin waiting will not be performed free.
Except for consumption loans, the demand for waiting as for labor and land
use derives from the factors capacity to contribute to output ultimately, output
of consumer goods and from consumers demand for that output. The relative
strengths of consumer demands for goods embodying relatively large amounts
of particular factors affect producer demands for those factors and so affect
their prices. A decline in consumer demand for a highly waiting-intensive good
tends to lower the rate of interest. This point was illustrated in the example of
matured wine, whose importation from abroad reduces the demand for its
domestically produced counterpart. A shift of consumers demand away from
low-waiting-content vodka toward high-waiting-content wine tends to raise the
interest rate.
Some comments are in order on the productivity of waiting or roundabout-
ness. Roundaboutness is the opportunity to get greater results from present
resources if one can wait a longer rather than a shorter period for those results
(see Bhm-Bawerk, 1959). Consider a house of definite specifications to be
delivered to the buyer on a definite date. The sooner (within limits) construc-
tion can begin and so the more time it can take, the smaller is the quantity of
inputs other than waiting required. (Compare Alchian, 1959, especially pp.
315, 39 and George 1898 [1941], pp. 36970.) The house probably could be
built in only five days as a stunt, but imagine the attendant inefficiencies and
expense. Adelman (1972, pp. 19, 63) notes an example of factor substitutabil-
ity in the oil industry:

The productivity of a pool is less than proportional to the number of wells because
past a certain point there is well interference. The area over which oil migrates

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