Reading Tom Woods book at the moment where he describes the interest rate as “like a price” (p. 66).
Would David Friedman’s critique of the term “price of money” be relevant here? I don’t quite get what Friedman is saying:
It is common for people who think they understand economics to describe the interest rate as the price of money. If it were true, then printing more money would lead to lower interest rates, and many of the same people think it does.
The next time someone tells you that the interest rate is the price of money, ask him what he thinks a reasonable interest rate is and offer to buy some money from him—at ten cents on the dollar if the rate he suggests is ten percent. As that example illustrates, the interest rate is not the price of money. The price of money is what you must give up to get it. If apples cost fifty cents each, the price of money is two apples. More generally, the price of money is the inverse of the price level—when prices are high, that means that money is not worth very much.
I think he’s referring to those who do not distinguish between the price of the use of someone else’s money - which I would assume he’d agree as interest rates for banking considerations - and the price of money proper - which is merely an inverse of the prices of other goods.
Other than that, I’m not sure what he’s getting at.
I don’t have the book but Woods could be correct, with a little more elaboration. Interest rates are the enchange rate between current dollars and future dollars. Current dollars buying more future dollars.
Interest rates represent the price of borrowing someone else’s capital (in this case, money). If I grow and pick five apples, sell them for $2.50, and someone wants to borrow that money for some reason, I will charge interest for the time I’m deprived of my money (my apples).
I think David is being picky here – interest rates aren’t the “price” of money per se, he’s trying to say you can, for example, “buy” $10 for $1 and never have to repay the $10 (net gain for you of $9). But interest rates are the price of borrowing money. He is correct…although he really could have phrased it a bit better.
[edit] - Likewise at the end of that quote, Friedman is probably again resorting to the “price of money” (not rate of interest)…so obviously if you increase the total supply of dollars from 100 to 200, the “price” of money, relative to total goods, has halved (assuming the number of goods hasn’t increased as well). So you now need twice as much money to get the same number of apples.
Well Friedman is correct, and Austrians make the same point. Interest is related to time preference (the price of time, in a way, or the amount of money someone is willing to forego for a higher amount later &c. &c.), NOT money per se. It only relates to money when credit expansion is the means of expanding the money supply, as in the current fiat monetary system. It’s common to hear people say interest is the price of money, so his critique is not misplaced.
Mr Friedman’s concept of the price of money vs interest rates makes sense to me too -but note that Woods says interest is “like a price”, and not “is the price” .
Interest, to me, is “the add-on price” to borrow future as yet unearned money now. Maybe that’s what Mr Woods means.
Mr Friedman of course then spoils it all by going on to claim that banks cannot fail these days because of the FDIC-oh well, dream on, Mr Friedman!
the interest rate is ‘like a price’ in that it is a ratio of exchange between two goods. (1$ per apple. or 1apple per dollar are ratios of exchange, prices)
in this sense, it is not just ‘like a price’ but it ‘is a price’
the one good is given up for the other good at some rate of exchange. with interest the exchange is between present and future goods.
it is indeed wrong to claim that money interest is the price of money. as this might mislead people to thinking of present price of money denominated in present money. Friedman was making the point that such a definition is silly. 1$ present trades with 1$ present. How insightful. Rather, it is the price of ‘future money in terms of present money.’ or more generally between money of one time period and money of another.
It seems to me that the interest rate is like a price in that it exchanges between two goods - present money and future money. It is unlike a price in that all other prices keep time constant and interest rate does not.
It should be noted that, to the extent that the interest rate is a price, the price is i+100, not just i. If the interest rate is 10%, and I borrow $100, I have to pay you back $110, which is 110%, not $10. This seems to eliminate the specific objection Friedman raises, but raises another one: If someone thinks that the interest rate is the price of money in this sense, then will he agree to buy $100 from me for $110? Surely not - because the price is a tradeoff between present and future goods.