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Interest

The rate of interest appears to us in either of the two forms ‘leading rate’ or ‘deposit rate’. Interest in an incentive is an incentive payment to attract depositors i.e., to encourage saving with the money and capital market. Thus it is a “deposit rate”. By contrast the rate of interest is also quoted as the cost of borrowed capital i.e., the price on pays for investment loans. Thus it is “lending rate” as well. There is an organic relationship between these two rates; normally the leading rate determines the profitability of financial institution and operations.

Traditionally, the rate of interest is seen as payment for “waiting” or “time preference” on “sacrifice” or a “premium for risk insured” and so on. The modern version is that it is simply an “opportunity cost” of holding cash idle in hand. The rate of interaction is determinant in the capital market thought the interest is determined in the capital market thought the interaction of investment (demand) and saving (supply) schedules. J M Keynes regarded ‘interest rate’ as the price of money, determined by the interplay of demand and supply forces in the money market. The ‘demand for money’ originates with either ‘transaction’ motive or ‘precautionary motive’ or ‘speculative motive’. The demand for money is essentially a desire to hold cash (liquidity) in hand to serve either of the three motives; the demand for money is thus called “liquidity preference”.

In today’s word, we have host of interest rates-short and long; and there is also a structural relationship among these rates. When we attempt an explanation of those rates and structure of interest rate, some of the traditional views do come very handy.