Re: Why is a dollar today worth more than a dollar tomorrow?
--- John Morrow [EMAIL PROTECTED] wrote: 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. So the question is, why at the zero rate was there not greater demand to borrow? The answer may well be that the expected future inflation and real interest rates were highly uncertain, and the transaction costs of getting and exiting from a loan were high, and there was a high level of risk aversion. What counts is not just the cost of borrowing but also the expected return on the borrowings, and if business conditions are bad, then the demand for loanable funds may be low because of uncertain earnings or asset appreciation. The inflation part of the nominal interest has to be paid in actual dollars, and so high rates of inflation may well deter demand. A low real rate of interest induces more borrowing, other things equal, but with higher inflation and greater business uncertatainty, other things may not be equal. Fred Foldvary = [EMAIL PROTECTED]
Re: Why is a dollar today worth more than a dollar tomorrow?
In a message dated 12/7/03 4:03:55 PM, [EMAIL PROTECTED] writes: So the question is, why at the zero rate was there not greater demand to borrow? The answer may well be that the expected future inflation and real interest rates were highly uncertain, and the transaction costs of getting and exiting from a loan were high, and there was a high level of risk aversion. What counts is not just the cost of borrowing but also the expected return on the borrowings, and if business conditions are bad, then the demand for loanable funds may be low because of uncertain earnings or asset appreciation. The inflation part of the nominal interest has to be paid in actual dollars, and so high rates of inflation may well deter demand. A low real rate of interest induces more borrowing, other things equal, but with higher inflation and greater business uncertatainty, other things may not be equal. In other words, a person won't borrow even at a 0% rate of interest if he expects a negative rate of return were he to invest any funds he borrowed? DBL
Re: Why is a dollar today worth more than a dollar tomorrow?
--- Marko Paunovic [EMAIL PROTECTED] wrote: OK. Then, as long as the expected profit from building a factory is higher than zero, I would not lend the money at zero interest rate. 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 Foldvary = [EMAIL PROTECTED]
Re: Why is a dollar today worth more than a dollar tomorrow?
I recall a Japanese econ grad student telling me that in fact real interest rates were negative for some span and people were STILL saving in the late nineties in Japan. He also blamed several bubbles at the time (notably, real estate in Japan) on this. Interesting if true... (Anyone know the details and can they justify the connection without resorting to framing biases of investors?) Following: 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. --Robert
Re: Why is a dollar today worth more than a dollar tomorrow?
In order for the government to borrow money, they would need to provide an incentive for the savers to lend. Example, if you want to borrow from me what incentive would I have to lending you my money? --- john hull [EMAIL PROTECTED] wrote: For some reason, I can't get it straight in my head why the risk-free rate of interest would be higher than zero. Does it really come from the fact that some people wish to consume today but can't, so they purchase current consumption from suppliers, i.e. lenders, and the interest rate is just the price in that particular market? Or is there something different, or deeper, or whatever going on? __ Do you Yahoo!? Free Pop-Up Blocker - Get it now http://companion.yahoo.com/ __ Do you Yahoo!? Free Pop-Up Blocker - Get it now http://companion.yahoo.com/
Re: Why is a dollar today worth more than a dollar tomorrow?
On 2003-12-05, john hull uttered: For some reason, I can't get it straight in my head why the risk-free rate of interest would be higher than zero. 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? That'd kill you, after all, because eating is consumption. This shows us that people have at least some urgent desires which aren't interchangeable with longer term ones. -- Sampo Syreeni, aka decoy - mailto:[EMAIL PROTECTED], tel:+358-50-5756111 student/math+cs/helsinki university, http://www.iki.fi/~decoy/front openpgp: 050985C2/025E D175 ABE5 027C 9494 EEB0 E090 8BA9 0509 85C2
Re: Why is a dollar today worth more than a dollar tomorrow?
On 2003-12-05, john hull uttered: For some reason, I can't get it straight in my head why the risk-free rate of interest would be higher than zero. 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? Sampo Syreeni, aka decoy - mailto:[EMAIL PROTECTED], tel:+358-50-5756111 That does not explain it, because many folks would save SOME of their income even if the interest rate were zero. Fred Foldvary = [EMAIL PROTECTED]
Re: Why is a dollar today worth more than a dollar tomorrow?
Let's see first what the risk-free interest rate really is. It depends on two conditions. One condition is that the borrower will certainly repay the money. The other condition is that the lender will certainly be alive to collect it when the time comes. That is probably the strongest reason why we prefer current consumption. We are just not sure whether we will be alive tomorrow. For the sake of argument, let's assume that people can't die. As I see it, money still has many uses. One of them is investing in a factory. So, I could build a factory and make some profit. In a risk-free world I can't fail. I might make small profit, but as long as it is positive, I am not willing to lend the money to somebody else for free. - Original Message - From: john hull [EMAIL PROTECTED] To: [EMAIL PROTECTED] Sent: Friday, December 05, 2003 16:29 PM Subject: Why is a dollar today worth more than a dollar tomorrow? For some reason, I can't get it straight in my head why the risk-free rate of interest would be higher than zero. Does it really come from the fact that some people wish to consume today but can't, so they purchase current consumption from suppliers, i.e. lenders, and the interest rate is just the price in that particular market? Or is there something different, or deeper, or whatever going on? __ Do you Yahoo!? Free Pop-Up Blocker - Get it now http://companion.yahoo.com/
Re: Why is a dollar today worth more than a dollar tomorrow?
--- Marko Paunovic [EMAIL PROTECTED] wrote: In a risk-free world I can't fail. Risk-free interest is quite different from a risk-free world. We need to assume the usual risky world, but a loan that is sure to be repaid and with the interest sure to be paid, which US treasury bonds currently come close to. Fred Foldvary = [EMAIL PROTECTED]
Re: Why is a dollar today worth more than a dollar tomorrow?
OK. Then, as long as the expected profit from building a factory is higher than zero, I would not lend the money at zero interest rate. Maybe to make a point more clear. As long as there is some opportunity for me to invest in a project with positive expected profits (whatever it is - building a factory, running a restaurant...) I would not lend the money at zero interest rate. And not just that. If I am really good at what I do, I would probably need some extra cash so I would be willing to pay someone to lend me that cash. As long as people are reasonably risk-averse, they will prefer giving money to me and risking it than giving it to someone else for free with no risk. So, if you assume that there is only one way of lending the money risk-free, while other ways are risky, there will always be someone who is willing to take that risk and be compensated for it. But then, it looks like a real world... That is why I assumed we live in a risk-free world. I guess the short answer to the question Why is a dollar today worth more than a dollar tomorrow? is Because there are some people who know how to take $1 today, transform it in $2 tomorrow and pay up to $1 for that. Marko - Original Message - From: Fred Foldvary [EMAIL PROTECTED] To: Marko Paunovic [EMAIL PROTECTED]; [EMAIL PROTECTED] Sent: Friday, December 05, 2003 21:58 PM Subject: Re: Why is a dollar today worth more than a dollar tomorrow? --- Marko Paunovic [EMAIL PROTECTED] wrote: In a risk-free world I can't fail. Risk-free interest is quite different from a risk-free world. We need to assume the usual risky world, but a loan that is sure to be repaid and with the interest sure to be paid, which US treasury bonds currently come close to. Fred Foldvary = [EMAIL PROTECTED]
