Positive Interest Rate, Stationary Economy, and Inefficiency

Positive Interest Rate, Stationary Economy, and Inefficiency

Amir Kia (Utah valley University, USA)
DOI: 10.4018/978-1-7998-0218-1.ch001

Abstract

This chapter analyses the direct impact of a positive rate of interest (usury) on the production possibility curve. Usury under a stationary state creates inefficiency in the sense that the marginal rate of transformation is not equal to the price ratio. Over the short run Pareto efficiency appears when a transition period is considered and the rate of return moving from one state to another is endogenous and equals the rate of investment. In a non-stationary economy, when a positive rate of return (interest) is equal to the growth rate of the economy, there will be a Pareto-efficient equilibrium. But if the interest rate is exogenous to the system, usury exists, and then Pareto efficiency cannot be achieved under any state, either stationary or non-stationary.
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Background

Numerous studies show that the existence of a predetermined positive rate of interest will lead to Pareto inefficiency in a stationary economy. However, in a timeless production system, a non-zero predetermined rate of interest cannot create inefficiency in a Pareto sense, that is, the cost minimization process under a competitive system leads to the equality of marginal rate of transformation and the price ratio. On the other hand, a time-phased system, both Ricardian and non-Ricardian, can be proved to be Pareto-efficient when the predetermined rate of interest is zero under perfect competition. M-S in their time-phased neo-Ricardian system proved that the existence of a predetermined positive rate of interest in a stationary state creates inefficiency in an economic system under perfect competition. The M-S proposition was studied by Samuelson (1975) who admitted that the existence of a predetermined positive rate of interest, under a stationary state, pushes the production possibility curve of the world inward. He also claimed that a positive rate of interest acts as distorting taxes. He contended that the intertemporal efficiency standpoint in a closed economy does not create a Pareto-efficient situation. Ethier (1979) also refers to the M-S model and questions how the rate of interest is exogenous when capital goods are supplied endogenously. For Dixit (1981), the stationary assumption is only a special instance of general equilibrium over time, and very far from reality. Pareto inefficiency was not followed in the existing literature. This chapter fills the gap.

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