06/27/18

Finance and Economics Free exchange

Negative justice Sub-zero interest rates are neither unfair nor unnatural.

Denmark's Maritime Museum in Elsinore includes one particularly unappetising exhibit: the world's oldest ship's biscuit, from a voyage in 1852. Known as hardtack, such biscuits were prized for their long shelf lives, making them a vital source of sustenance for sailors far from shore.

They were also appreciated by a great economist, Irving Fisher, as a useful economic metaphor. Imagine, Fisher wrote in The Theory of Interest in 1930, a group of sailors ship wrecked on a barren island with only their stores of hardtack to sustain them.

On what terms would sailors borrow and lend biscuits among themselves? In this for lorn economy, what rate of interest would prevail?

One might think the answer depends on the character of the unfortunate sailors. Interest, in many people's minds, is a reward for deferring gratification.

That is one reason why low interest rates are widely perceived as unjust. If an abstemious sailor were prepared tolend a biscuit to his crewmate rather than eating it immediately himself, he would deserve more than one biscuit in repayment.

The rate of interest should be positive- and the sharper the hunger of the sailors, the more positive it would be. In fact, Fisher pointed out, the interest rate on his imagined island could only be zero.

If it were positive, any sailor who borrowed an extra biscuit to eat would have to use more than one biscuit in the future to repay the loan. But no sailor would accept those terms because he could instead eat one more piece from his own supply, thereby reducing his future consumption by one, and only one, piece.