Date: Fri, 05 Dec 2003 16:33:07 -0800
From: Fred Foldvary <[EMAIL PROTECTED]>

John Hull:
> >For some reason, I can't get it straight in my head why the risk-free
> >rate of interest would be higher than zero.

Sampo Syreeni:
> The easiest example I know of is, would you be happy saving all of your
> income for the next year, without receiving a formidable compensation?

Fred Foldvary on Dec. 5:
> That does not explain it, because many folks would save SOME of their
> income even if the interest rate were zero.

Fred Foldvary on Dec. 6:
> If at a zero rate of interest, the quantity of savings exceeds the quantity
> of borrowings, savers would earn zero interest.  Borrowers would just pay
> the overhead costs and a risk premium and an inflation premium.  You as
> lender would earn a wage for engaging in the lending business, but the pure
> interest rate would be zero.  The reason the interest rate is positive is
> that at a zero rate, the quantity of funds demanded for loans exceeds the
> quantity of loanable funds from savings, so this scarcity drives up the
> rate just as with other prices.

Fred, I think you answered your own question -- even if many people
would save some of their money even if the risk-free interest rate
were zero, the quantity of funds demanded by borrowers at this rate
would exceed the amount saved.  So, a positive interest rate induces
some people to defer consumption (save) and others to borrow less,
until the market clears.

And this would be the case even if there were no risk of nonpayment,
and no inflation/deflation.

By the way, there have been times and places where the measured real
interest rate was essentially zero; I think this happened in Japan in
the 1990s.


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