Friday, October 17, 2014

The Proto-Natural Rate of Interest and Henry Thornton

Smithin (2003: 92, citing Laidler 1989 and Humphrey 1993) points out that the germ of Wicksell’s monetary equilibrium approach, with a proto-natural rate and bank rate, appears already in Henry Thornton’s book An Enquiry into the Nature and Effects of the Paper Credit of Great Britain (1802):
“It only remains to enquire, lastly, whether any principle of moderation and forbearance on the part of the borrowers at the bank may be likely to exempt the directors of that institution from the necessity of imposing their own limit.

It may possibly be thought, that a liberal extension of loans would soon satisfy all demands, and that the true point at which the encrease of the paper of the bank ought to stop, would be discovered by the unwillingness of the merchants to continue borrowing.

In order to ascertain how far the desire of obtaining loans at the bank may be expected at any time to be carried, we must enquire into the subject of the quantum of profit likely to be derived from borrowing there under the existing circumstances. This is to be judged of by considering two points: the amount, first, of interest to be paid on the sum borrowed; and, secondly, of the mercantile or other gain to be obtained by the employment of the borrowed capital. The gain which can be acquired by the means of commerce is commonly the highest which can be had; and it also regulates, in a great measure, the rate in all other cases. We may, therefore, consider this question as turning principally on a comparison of the rate of interest taken at the bank with the current rate of mercantile profit.

The bank is prohibited, by the state of the law, from demanding, even in time of war, an interest of more than five per cent., which is the same rate at which it discounts in a period of profound peace. It might, undoubtedly, at all seasons, sufficiently limit its paper by means of the price at which it lends, if the legislature did not interpose an obstacle to the constant adoption of this principle of restriction.” (Thornton 1802: 286–287).
So here the “current rate of mercantile profit” is the non-monetary, real “natural” rate which is the anchor for the bank rate. That corresponds to Wicksell’s natural rate:
“The rate of interest at which the demand for loan capital and the supply of savings exactly agree, and which more or less corresponds to the expected yield on the newly created capital, will then be the normal or natural real rate. It is essentially variable.” (Wicksell 1935: 192–193).

“According to the general opinion among economists, the interest on money is regulated in the long run by the profit on capital, which in its turn is determined by the productivity and relative abundance of real capital, or, in the terms of modern political economy, by its marginal productivity. (Wicksell 1907: 214).

Humphrey, Thomas M. 1993. Money, Banking, and Inflation: Essays in the History of Monetary Thought. Edward Elgar, Aldershot, UK and Brookfield, VT.

Laidler, David. 1989. “The Bullionist Controversy,” in J. Eatwell. M. Milgate. and P. Newman (eds), The New Palgrave. Money. Macmillan, London. 60–71.

Smithin, John N. 2003. Controversies in Monetary Economics (rev. edn.). Edward Elgar, Cheltenham, UK and Northhampton, MA.

Thornton, Henry. 1802. An Enquiry into the Nature and Effects of the Paper Credit of Great Britain. J. Hatchard, London.

Wicksell, K. 1907. “The Influence of the Rate of Interest on Prices,” The Economic Journal 17.66: 213–220.

Wicksell, K. 1935. Lectures on Political Economy. Volume 2: Money (trans. E. Classen). Routledge & Kegan Paul, London.

1 comment:

  1. Thank you LK, for your excellent research.I think it´s important to get the full context and history behind those ideas to fully understand them and valuate them. Indeed did Henry Thornton preceed Wicksell.But it actually seems like Knut Wicksell was unaware of Henry Thornton until late in life.It was Wicksell´s collegue David Davidson that made him aware of Thornton as late as 1916 in public debate.By the way i run in to internet Austrians,time after time,that claim something i think it emanates from Hayek in some interview somewhere, that Keynes never understood Wicksell or even read him. This is of course utter nonscence! Keynes booth read and understood Wicksell very well and even meet Knut Wicksell in 1916.They meet and had lunch and Knut Wicksell was very impressed "to talk with the most gifted young spirit in Cambridge" as Thorsten Gårdlund writes.And Keynes was also a driving force to get Wicksell´s work
    translated to english according to Bertil Ohlin one of Wicksell´s own students.Ohlin and Keynes know each other personally since mid 1920s and corresponded lively throw out their whole life.Of course did Keynes have full understanding of Wicksell from best available sources,something F.A Hayek never had.