The Price of Time: A Study Guide

Short-Answer Quiz

* Explain Proudhon's view of interest and his proposed solutions.

* How does Bastiat differentiate between a good and bad economist and what is the key fallacy that a bad economist falls prey to?

* What is Schumpeter’s concept of ‘creative destruction’ and how is it related to interest rates?

* How did central banks react to the 2008 financial crisis, and what were the unexpected consequences of their actions?

* What is the historical relationship between low interest rates and speculative manias?

* What is the ‘time value of money’ and why does the author consider it the most encompassing view of interest?

* How did ancient Mesopotamians use interest, and what were some common payment methods?

* What was the key innovation that allowed northern Italian bankers to engage in lending despite religious restrictions?

* According to the text, what is the problem with the idea that money is only meant for exchange and not a store of value?

* How does the text describe the role of low interest rates in market concentration, and why does that hinder economic growth?

Quiz Answer Key

* Proudhon viewed interest as theft, arguing that it exploited the poor. His solutions included nationalising the Banque de France, expanding the money supply, reducing interest rates to near zero, and implementing a tax on capital.

* A good economist considers both the immediate and long-term consequences of a policy, while a bad one focuses only on the immediate effects. The key fallacy is overlooking secondary consequences, thereby favouring short term gain.

* Schumpeter describes capitalism as a process of continuous transformation, with old structures being destroyed and new ones created. The text shows how interest facilitates creative destruction by determining what investments are viable or not.

* After the Lehman Brothers bankruptcy, central banks pushed interest rates to historically low levels, even negative in some regions. This led to slow income growth, proliferation of low-paying jobs and increased borrowing at high rates for the less well-off.

* Speculative manias often coincide with periods of low interest rates as it encourages investors to seek out riskier ventures. The text shows this happened during the Dutch Tulip mania, the canal building craze of the 1790s and in the housing bubble leading up to the 2008 crisis.

* The 'time value of money' acknowledges that money is worth more now than in the future, hence a price of time. It is the most encompassing view of interest as it highlights how interest rates affect every economic deliberation.

* Ancient Mesopotamians charged interest on loans, often in the form of the same commodity that was lent such as silver, or in kind with dates, firewood or labour services. Temples and palaces were major providers of these loans.

* Northern Italian bankers concealed interest using euphemisms such as "yield", "gain", or by incorporating interest in foreign exchange transactions, which were called 'dry exchange', where no sea was crossed. This practice allowed them to bypass religious prohibitions.

* The claim that money is only for exchange overlooks that money is also a store of value, which is the reason why lenders charge interest for the use of their money over time as it is an intertemporal transaction.

* Low interest rates have led to increased market concentration, which in turn has led to higher profits for some and fewer new firms. According to the text, monopolies create barriers to entry which discourage innovation and slow economic growth.

Essay Questions

* Discuss the role of custom, law and monetary regimes in determining interest rates throughout history, using examples from the text to support your argument. How have these factors interacted to shape economic outcomes?

* Evaluate the arguments for and against interest, considering different perspectives like those of Proudhon, Bastiat, Aristotle, and modern economists. Is interest a necessary evil, or a fundamental component of a healthy economy?

* Analyse the relationship between low interest rates and speculative bubbles, using historical examples from the text to illustrate your arguments. How do central banks contribute to this phenomenon, and what measures can be taken to mitigate its consequences?

* Explore the concept of ‘malinvestment’ and its connection to ultra-low interest rates. How does malinvestment occur, and what are its long-term consequences for economic growth and stability?

* Examine the challenges and controversies associated with central bank inflation targets and the pursuit of low interest rate policies in the 21st century. How have these policies affected different groups and what alternatives are proposed in the text?

Glossary of Key Terms

* Creative Destruction: A concept by Joseph Schumpeter describing the capitalist process where new innovations and businesses replace older ones.

* Time Value of Money: The idea that money available now is worth more than the same amount in the future due to its potential earning capacity.

* Usury: The practice of lending money at an unreasonably high interest rate. Historically viewed negatively.

* Malinvestment: Investments made unwisely, often during periods of low interest rates, that do not generate adequate returns.

* Liquidity Trap: An economic situation where low interest rates do not stimulate investment or spending.

* Zombie Firms: Companies that are unable to cover their interest payments from profits, kept afloat by low interest rates.

* Fiat Money: Currency that is not backed by a physical commodity like gold, but rather by government decree or public confidence.

* Carry Trade: A trading strategy in which an investor borrows money in a currency with a low interest rate and invests it in another currency with a higher rate.

* Moral Hazard: A situation where one party takes more risks because they know that another party will bear the cost of those risks.

* Dry Exchange (Cambi Secchi): A method used by northern Italian bankers to conceal interest by incorporating it into foreign exchange transactions without any real transaction taking place.

* Inflation Target: A specific level of inflation that a central bank aims to maintain, often set at 2%.

* Quantitative Easing: A monetary policy in which a central bank introduces new money into the money supply by purchasing assets.

* Debt Jubilee: A periodic debt cancellation or wiping clean of slates to help relieve debtors.

* The Wage of Abstinence: An older view of interest, where the interest rate is seen as payment for a lender's saving and not spending.

* Monetary Regime: A set of rules and customs that determine the nature and value of a country's currency.

* Financial Drag: The impact of debt on an economy, where households and businesses reduce spending to repair balance sheets.

* Rentier: A person who lives off interest.

* Leverage: The use of borrowed capital to increase the potential return of an investment.

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