What’s The Correct Interest Rate?

A similar question is, “Is there a correct interest rate?”

The answer is interest is a signal, a price if you like that description better, and prices guide our behaviours. Economics is about incentives and tradeoffs. The price of money, interest, fits both spaces. We should learn how that works.

Interest that is too low

This generally induces distortions. When rates are too low, people tend to borrow money for purposes they might avoid if they were higher. That usually means capital ends up in suboptimal situations. If interest is reasonable or higher, people study the opportunity more closely.

Low interest is an incentive, in some cases, a moral hazard. It incentives risky and or non-productive behaviour.

Interest that is too high

.High interest suppresses spending on capital assets and on consumer goods like automobiles, housing, and others. Suppressed spending by businesses reduces productivity improvements and, for some, makes their goods more difficult for customers to acquire.

Some thoughts from smart people

“Government has three primary functions. It should provide for the military defence of the nation. It should enforce contracts between individuals. It should protect citizens from crimes against themselves or their property. When government—in pursuit of good intentions—tries to rearrange the economy, legislate morality, or help special interests, the cost comes in inefficiency, lack of motivation, and loss of freedom. Government should be a referee, not an active player.” Milton Friedman

Easy money creates economic distortions . . . it tends to encourage highly speculative ventures that cannot continue except under the artificial conditions that have given birth to them. On the supply side, the artificial reduction of interest rates discourages o thrift, saving, and investment. It reduces the accumulation of capital. It slows down that increase in productivity, that ‘economic growth’ that ‘progressives’ profess to be so eager to promote.'” Henry Hazlitt

“The persistent tendency of men to see only the immediate effects of any given policy, or its effects on only a special group, and to neglect to inquire what the long-run effects of that policy will be not only on the special group but on all groups. It is the fallacy of overlooking secondary consequences” Henry Hazlitt.

The bit to take away

The government looks for the intended immediate effect of their policies and actions. They often don’t adjust when adverse secondary effects appear. You need to be your own protector.

I build strategic, fact-based estate and income plans. The plans identify alternate ways to achieve spending and estate distribution goals. In the past, I have been a planner with a large insurance, employee benefits, and investment agency, a partner in a large international public accounting firm, CEO of a software start-up, a partner in an energy management system importer, and briefly in the restaurant business. I have appeared on more than 100 television shows on financial planning. I have presented to organizations as varied as the Canadian Bar Association, The Ontario Institute of Chartered Accountants, The Ontario Ministry of Agriculture and Food, and Banks – from CIBC to the Business Development Bank.

Be in touch at 705-927-4770 or by email at don.shaughnessy@gmail.com.

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