ABSTRACT
As was argued in the last chapter, the relationship between the owners and the users of capital is a complex one; and that is true even where the connection between them is the relatively straightforward one of lending money at interest. In some places and periods there may be little capital raised for investment even though its price, the rate of interest, is low; in others, although that rate is high, much may be raised and spent. Nonetheless, it is clear that a low interest rate does tend to raise the rate of investment, and thus the rate of economic growth. Interest rates may be defined and measured in two ways: nominal and real. The former are those which meet the eye; the latter are those which really count. The real interest rate is, the nominal interest rate less the rate of price increase (or plus the rate of price decrease). Thus if the nominal rate of interest is 10 per cent per annum but the rate of inflation is also 10 per cent, the real rate of interest is nil; on the other hand, if the nominal rate is 10 per cent but prices are falling at 10 per cent a year, the real rate is 20 per cent. Clearly a prospective borrower would be much encouraged by the former situation, deterred by the latter. Unfortunately, unlike the nominal rate of interest, which is usually fixed over the period of the loan, the rate of price increase is not at all certain. The rate of price inflation or disinflation which counts, when calculating the real interest rate, is that expected by the borrower, over the period of the loan. Expectations start from experience, so we shall begin by looking at price movements over the long wave, in the industrialised, Northern countries where the key interest rates are determined.
