This is based on a comment I made here.
The interest rate is NOT the price of money. The price of money is what you can get for it (in terms of goods and services). (I am talking here of the real price of money, the nominal price of money is one.)
The interest rate includes expectations about the future price of money. It is, at best, the price of borrowing money. (If you like, the price of credit.) If money is expected to get more scarce, the price of borrowing tends to go down, if money is expected to get less scarce, the price of borrowing it tends to go up. So the price of borrowing money does not operate as it would if it were "the price of money".
It is better to think of interest rates as the cost of holding money, including therein expectations about the future price of money.
This confusion matters, because you get people (even economists who should know better) speaking as if low interest rates are a sign that money is loose, when they are generally a sign of exactly the opposite, as Milton Friedman would point out.
"If money is expected to get more scarce, the price of borrowing tends to go down, if money is expected to get less scarce, the price of borrowing it tends to go up."
ReplyDeleteI'm confused. I thought it was the opposite.
Anon: money can be spent or held. Money that is being spent is not available to being borrowed. So, the less money folk are spending and the more they are holding the greater the supply of money to borrow. Alas, the less they are spending, the lower investment is likely to be, so the lower the demand for money to borrow. So the price of credit goes down precisely because less money is circulating (i.e. being spent).
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