Sunday, 9 November 2008

On interest and the Nov. 6 rate cuts

Among the non-Obama related news is a massive Bank of England cut in the cost of borrowing by 1.5 per cent and the European Central Bank's cut of .5 per cent. The cuts came alongside a gloomy International Monetary Fund report forecasting 2009 to be the first contraction of industrialized countries since WWII. Meanwhile, the Financial Times has continued to report that inflation is set to fall along with declining commodity prices.

The aim of the interest rate cut is both to loosen credit to allow for the continued daily functions of capital and hopefully to increase investment, which would then combat falling prices. But how should we understand the determinants of the rate of interest? Academic economists theorize the longer term tendencies of the interest rate more than day to day shifts. Neoclassical economists assume that the average rate of interest and the average (or general) rate of profit equate in equilibrium. Here, the sheer mobility of money capitalists and productive capitalists will tend to generate an equalization of returns. Marx however, disagreed.

Marx's thoughts on the rate of interest are somewhat scattered and fragmented. He did not however seem to believe that the rate of interest was determined by the same laws of motion which determined the general rate of profit, ie, the technical conditions of production. He says in volume III of Capital: "The prevailing average rate of interest in a country, as distinct from the constantly fluctuating market rate, cannot be determined by any law. There is no natural rate of interest, therefore in the sense that economists speak of a natural rate of profit and a natural rate of wages."

While there is no general theory of the average rate of interest, he does say a few things about it's determinants. He indicates that the average rate of interest will fall below the general rate of profit and above zero. For if the average rate of interest and the general rate of profit were equal, where would be the incentive on the part of any individual capitalist to go through the difficult and uncertain process of production; much easier would be to simply lend and collect. Thus there must be rewards to "profit of enterprise." Marx also notes that the average rate of interest depends to some extent on the supply and demand of money capital.

Additionally, it must be noted that the interest of money capitalists does not reflect any contribution to the production of value. Instead it is a deduction on "profit of enterprise" or industrial capital. That is, surplus value is divided between what productive capital keeps and what must be paid out to money capital in interest. This might be why he refers to them as "parasites" and "bandits". Again, Marx notes: "It is indeed only the separation of capitalists into money-capitalists and industrial capitalists that transforms a portion of the profit into interest, that generally creates the category of interest; and it is only the competition between these two kinds of capitalists which creates the rate of interest."

Regarding day to day fluctuations of interest and central bank policy, Marx seems to deny that monetary authorities take the role of prime mover: "An ignorant and mistaken legislation ... may intensify a money crisis. But no manner of bank legislation can abolish a crisis." This, in a post gold-standard era, is because of the central bank's perpetual struggle to both avoid the devaluation of commodities and maintain money as the reflection of social labor (on this point see David Harvey, Limits to Capital, 2006, p. 294). In a crisis, the contradiction of a central bank may be between devaluing money on the one hand via inflation that is caused by lowering interest rates (low interest rates prompt investment and an increase in the money supply hopefully generating more production and higher prices, which is why unions have backed the move), and allowing commodities to devalue in a recession or depression. Put more generally, the problem for Marx is the simultaneous management of "capital in its money form and capital in its commodity form." Currently we are seeing the inflation/devaluation strategy. In a period of falling inflation, especially in Europe, central banks are hoping the drastic rate cuts will both to loosen credit and prop up prices of goods so to better reflect their value. Savers on the other hand are rightly worried about the value of their currency.

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