Interest Rate
This article is part of the Basic Liberalism Course -> Module 5: Notions of Austrian Economics
Last updated: 2026-04-10
To understand this topic, it is required to have read -> Time Preference.
Definition
The interest rate, according to the Austrian School of Economics, is fundamentally the price of time or, more precisely, the market expression of individuals' time preference.
Central Concept (Böhm-Bawerk, Mises, Rothbard, Hülsmann)
The interest rate is not an arbitrary monetary phenomenon, nor a “cost of money” imposed by banks or central banks. It is a real phenomenon that arises from human time preference: the natural tendency of human beings to value present goods more than future goods of equal quality and quantity.
- Eugen von Böhm-Bawerk (in The Positive Theory of Capital, 1889) explained that the interest rate is the premium of present goods over future goods. It arises because people, on average, prefer to consume now rather than wait. This time preference determines how much they are willing to sacrifice present consumption (saving) in exchange for greater future consumption.
- Ludwig von Mises synthesized it masterfully:
- “The originary interest rate is the percentage (result of the division) between the valuation of present goods and future goods”.
- It is a categorical element of human action (praxeology): as long as there is human action, there will be positive time preference (except in extreme pathological cases).
The interest rate in the free market
In a market economy without monetary intervention:
- The natural interest rate (or originary rate) balances the supply of voluntary saving (present goods renounced) with the demand for loanable funds for longer-term investment projects (higher-order goods, according to the structure of production).
- It is determined subjectively by individual valuations, not by the quantity of money.
- A lower interest rate reflects a lower time preference (greater willingness to save and undertake long-term projects).
- A higher rate reflects greater impatience (preference for immediate consumption).
This is consistent with the theory of capital and the productive structure of Hayek and Böhm-Bawerk: interest rates coordinate the length of productive processes with the real availability of saving.
Austrian critique of interest rate manipulation
The Austrian School (especially the Austrian Theory of the Business Cycle of Mises-Hayek) holds that when central banks or the fractional reserve system artificially lower the interest rate below its natural level:
- An artificial credit boom is generated.
- Entrepreneurs receive a false signal that there is more real saving than actually exists.
- Productive processes are unduly lengthened (malinvestments).
- Eventually, a real shortage of capital goods occurs, leading to the crisis and corrective recession.
Therefore, for Austrians, the interest rate should be determined exclusively by the market (supply and demand for voluntary saving), never by central authority. Any intervention distorts intertemporal economic calculation.
Summary in an Austrian phrase:
- “The interest rate is the price that equalizes the subjective valuation of time between savers and investors. It is not an instrument of policy, but a praxeological phenomenon derived from human action.”
This article is part of the Basic Liberalism Course -> Module 5: Notions of Austrian Economics
| Previous Topic | Next related topic | |
|---|---|---|
| <-Time Preference | <-----> | The Problem of the Economic Cycle -> |
Last updated: 2026-04-10
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