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Interest and Responsibility

Since at least the middle ages, the payment and receipt of interest has existed under a moral cloud, due mainly to a misunderstanding concerning what interest is and why it exists. Medieval theologians gradually came around to the view that now prevails in economic science.

What connects all forms of interest is the insight that interest is nothing more or less than the exchange ratios between different time horizons. If I prefer to save now, I must put off current consumption. If you prefer to spend now, you must acquire the resources to do so. We can make an exchange between the money you want to spend and the money I want to save. I agree to lend you money, and we negotiate a fee to put to work what might otherwise have been idle resources.

In doing so, of course, I cannot dictate the terms because I must depend on your willingness to pay and I must compete with other lenders who want your business. The result is the interest rate, which is the agreed-upon price differential that reflects the degree to which people prefer consumption over saving.

And let us not make mistakes that the early medieval theologians made in questioning the moral status of interest. In the parable of the talents (Mathew 25:14–30), the last servant is chastised: “Then you ought to have put my money in the bank, and on my arrival I would have received my money back with interest” (verse 29). To have not earned interest was considered by the master to be losing money.

The same is true of all interest. Capital earns a return comparable to the going rate of interest because capital must be accumulated over time at the expense of current consumption. Banks and mortgage companies earn interest because they specialize in accumulating non-consumed sources of capital and putting it to use in the form of current spending, via a freely agreed upon contract.

The preference for present versus future consumption can involve a moral component. For example, a credit card in the hands of a young college student can be a wonderful tool for obtaining essential services and providing a convenient means of navigating the day-to-day business of going to school. Or it can be an enabler of profligacy that leads to personal and financial catastrophe. Actually, we can make the same point about adults. Credit cards can be an essential tool but they can also encourage extraordinary vice based on a distorted sense.

People often complain about the high rates of interest on credit card debt, and legislation is often put forward to cap what credit card companies are charging, as if they were simply taking advantage of borrowers.

But consider this: interest rates are only high if a balance is carried over from month to month, and sometimes they grow the longer a balance is carried over. This has the effective of discouraging this kind of behavior relative to what it would be if the interest rate were lower.

Thus can we see how the interest rate helps encourage responsible behavior. It rewards those who save while it asks a fee from those who consume now. Not only that, it manages to do so on a sliding scale. The more you save, the more your rewards; the more you borrow, the more one is expected to pay for the privilege. We might say that that interest rate is yet another miracle of the market.