The Theory of Interest

By Irving Fisher

THE tremendous expansion of credit during and since the World War to finance military operations as well as post-war reparations, reconstruction, and the rebuilding of industry and trade has brought the problems of capitalism and the nature and origin of interest home afresh to the minds of business men as well as to economists. This book is addressed, therefore, to financial and industrial leaders, as well as to professors and students of economics.Inflation during and since the War caused prices to soar and real interest rates to sag in Germany and other nations far below zero thus impoverishing millions of investors. In all countries gilt-edge securities with fixed return became highly speculative, because of the effect of monetary fluctuations on real interest rates. After the War the impatience of whole peoples to anticipate future income by borrowing to spend, coupled with the opportunity to get large returns from investments, raised interest rates and kept them high. Increased national income has made the United States a lender nation. At home, real incomes have grown amazingly because of the new scientific, industrial, and agricultural revolutions. Interest rates have declined somewhat since 1920, but are still high because the returns upon investments remain high. Impatience to spend has been exemplified by the organization of consumers’ credit in the form of finance companies specially organized to accommodate and stimulate installment selling and to standardize and stabilize consumption…. [From the Preface]

Book Cover

First Pub. Date

1930

Publisher

New York: The Macmillan Co.

Pub. Date

1930

Comments

1st edition.

Copyright

The text of this edition is in the public domain.

§ 1 (to Ch. XIX, § 4)

Tables giving basic data

APPENDIX TO CHAPTER XIX

In Chapter XIV of
The Rate of Interest “virtual,” or “real,” rates of interest were computed from “nominal,” or “money,” rates of interest by making adjustments for appreciation in the value of money calculated from index numbers of prices. In this book, the money rates of interest are adjusted directly to the rates of change in the general price level. These two methods, of course, yield identical results, since the one is the obverse of the other.

The average annual percentage changes in the general price level, given in the Tables VII to XI inclusive, are computed from the wholesale price indexes of the several countries. The index numbers for two dates, as 1825 and 1834, give us a measure of the price level at those two dates, and from these it is easy to calculate the average annual percentage change. The method is the same as that employed for finding the rate of interest by which $1, by compounding, will amount to a given sum in a given time. Theoretically, since the loans here included run usually perhaps thirty to ninety days, the quotations of rates of interest averaged should begin at the first of the two dates, and cease, say, sixty days before the second. But the index numbers are not always for definite points of time, nor can the interest quotations be subjected to such minute corrections without an immense expenditure of labor. Hence, the method adopted has been to average the rates for all the years of a period, e.g., for the ten years, 1824-1834. The annual percentage change in the price level is reckoned between those dates. If the index numbers present the price levels at the middle of 1825 and 1834, then the average interest rates ought in theory to include only the last six months of 1825 and the first four months of 1834. But it seems better to include too much at both ends than to omit the averages for 1825 and 1834 altogether, for the reason that an average is the more valuable the greater the number of terms included.

The real interest rates are obtained by subtracting from the money rate for any period the rate of annual change in the price level for the same period.

TABLE VII Rates of Interest in Relation to Annual Rates of Change in the Price Level, London, 1825-1927
	BANK RATE	MARKET RATE	ANNUAL RATES OF CHANGE IN THE PRICE LEVEL	REAL INTEREST IN COMMODITIES (BANK)	REAL INTEREST IN COMMODITIES (MARKET)
1825-1834	4.2	3.4	-3.0	+7.2	+6.4
1834-1839	4.4	4.0	+3.3	+1.1	+0.7
1839-1852	3.7	3.4	-2.7	+6.4	+6.1
1852-1857	3.8	4.7	+5.8	-2.0	-1.1
1858-1864	4.4	4.2	+2.4	+2.0	+1.8
1864-1870	4.3	4.1	-1.6	+5.9	+5.7
1870-1873	3.7	3.5	+4.8	-1.1	-1.3
1873-1896	3.2	2.5	-2.6	+5.8	+5.1
1896-1913	3.6	3.1	+1.9	+1.7	+1.2
1914-1920	5.2	4.4	+14.5	-9.3	-10.1
1920-1927	4.8	4.2	-10.9	+15.7	+15.1

TABLE VIII Rates of Interest in Relation to Annual Rates of Change in the Price Level, New York, 1860-1927
	PRIME TWO NAME 60-90 DAY COMMERCIAL PAPER RATES	ANNUAL RATES OF CHANGE IN THE PRICE LEVEL	REAL RATE OF INTEREST IN COMMODITIES (MARKET)
1860-1865	6.9	-14.3	-7.4
1865-1871	7.8	+8.1	+15.9
1871-1879	6.4	-4.3	+10.7
1879-1889	5.1	-0.2	+5.3
1889-1896	4.9	-3.1	+8.0
1896-1915	4.7	+2.1	+2.6
1915-1920	5.1	+14.9	-9.8
1920-1927	5.0	-6.3	+11.3

TABLE IX Rates of Interest in Relation to Annual Rates of Change in the Price Level, Berlin, 1864-1912
	BANK	MARKET	ANNUAL RATES OF CHANGE IN THE PRICE LEVEL	REAL INTEREST IN COMMODITIES (BANK)	REAL INTEREST IN COMMODITIES (MARKET)
1864-1867	5.1	4.7	+5.0	0.1	-0.3
1867-1870	4.2	3.3	-4.5	+8.7	+7.8
1870-1873	4.6	4.2	+8.2	-3.6	-4.0
1873-1886	4.2	3.2	-4.3	+8.5	+7.5
1886-1891	3.7	2.7	+6.2	-2.5	-3.5
1891-1896	3.5	2.5	-5.9	+9.4	+8.4
1896-1912	4.4	3.5	+2.6	+1.8	+0.9

TABLE X Rates of Interest in Relation to Annual Rates of Change in the Price Level, Paris, 1872-1914
	BANK	MARKET	ANNUAL RATES OF CHANGE IN THE PRICE LEVEL	REAL RATE OF INTEREST IN COMMODITIES (BANK)	REAL RATE OF INTEREST IN COMMODITIES (MARKET)
1872-1896	3.2	2.6	+2.4	+0.8	+0.2
1896-1914	3.0	2.6	-2.0	+5.0	+4.6

TABLE XI Rates of Interest in Relation to Annual Rates of Change in the Price Level, Calcutta, 1861-1926, Tokyo, 1887-1926
	BANK	ANNUAL RATES OF CHANGE IN THE PRICE LEVEL	REAL RATE OF INTEREST IN COMMODITIES (BANK)
Calcutta, 1861-1866	6.6	+5.7	+0.9
1866-1871	6.1	-6.0	+12.1
1871-1875	5.8	+5.4	+0.4
1878-1881	5.4	-11.2	+16.6
1883-1897	5.5	+3.1	+2.5
1897-1899	7.3	-11.2	+18.5
1899-1901	5.6	+6.9	-1.3
1901-1904	5.1	-4.8	+9.9
1904-1913	5.6	+4.4	+1.2
1913-1920	5.9	+11.2	-5.3
1920-1926	5.9	-5.2	+11.1
Tokyo, 1887-1899	7.0	+3.8	+3.2
1899-1902	8.7	-2.6	+11.3
1902-1913	6.9	+2.9	+4.0
1913-1920	7.0	+12.7	-5.7
1920-1926	7.8	-6.4	+14.2

§ 2 (to Ch. XIX, § 6)

Tables of interest rates

TABLE XIII Interest Rates on 15 Railroad Bonds, United States, 1900-1927
YEAR	AVERAGE PER CENT	YEAR	AVERAGE PER CENT	YEAR	AVERAGE PER CENT
1900	4.05	1910	4.16	1920	5.79
1901	3.90	1911	4.17	1921	5.57
1902	3.86	1912	4.21	1922	4.85
1903	4.07	1913	4.42	1923	4.98
1904	4.03	1914	4.46	1924	4.78
1905	3.89	1915	4.64	1925	4.67
1906	3.99	1916	4.49	1926	4.51
1907	4.27	1917	4.79	1927	4.31
1908	4.22	1918	5.20
1909	4.06	1919	5.29

SOURCE:
The Statistical Bulletin of The Standard Statistics Company, Inc., 1929-1930, page 58.

The Wholesale Price Indexes used in making correlations are the indexes of the United States Bureau of Labor Statistics given in Table II.