The interest rate is not the price of money
(Just a quick one, on a topic I am still highly uncertain and confused about. So be nice.)
I’ve been taught no less than three times that the interest rate is the price of money: once at school, once at college and once again at CFA class. And that doesn’t seem right to me.
First, consider a world without money. I offer you one sheep in exchange for two this time next year. The interest rate is 100%. It expresses the rate at which consumption can be shifted through time.
Second, consider a world where everyone adhered to Polonius’ admonition to neither a borrower nor a lender be. There is still money in this world. It is traded for goods and services. The price of money is the rate at which it is traded for goods and services. That is to say, it is what we normally call ‘the price level’.
So money is not essential to the existence of interest rates, and interest rates are not essential to the existence of money. As the medium of exchange, the price of everything is expressed in terms of money. There is no more a case for the price of future consumption being “the” price of money than the price of kumquats. A price is nothing more and nothing less than the rate at which things are exchanged, and money can be exchanged for anything. Considering this, I find it hard to see why setting an interest rate is the ‘essence’ of monetary policy, because it’s just one price among many. That we do it this way just seems like a historical accident.
This is also by way of saying that while I understand the zero-lower-bound issue under the current monetary system, the reason why it’s an issue at all is because normal monetary operations revolve around exchanging an asset that, under certain circumstances, becomes highly substitutable with money*.
Maybe we should choose a different one.
*This is also the only way I have been able to understand the ‘QE is just an asset swap’ objection, but that could be as much to do with my feeble brain as the quality of explanation on offer