CHAPTER 14

THE CLASSICAL THEORY OF THE RATE OF INTEREST

I

What is the Classical Theory of the Rate of Interest?It is something upon which we have all been brought upand which we have accepted without much reserve untilrecently. Yet I find it difficult to state it precisely orto discover an explicit account of it in the leadingtreatises of the modern classical school .1

It is fairly clear, however, that this tradition hasregarded the rate of interest as the factor which bringsthe demand for investment and the willingness to saveinto equilibrium with one another. Investment re-presents the demand for investible resources and savingrepresents the supply, whilst the rate of interest is the“price” of investible resources at which the two areequated. Just as the price of a commodity is necessarilyfixed at that point where the demand for it is equal to thesupply, so the rate of interest necessarily comes to restunder the play of market forces at the point where theamount of investment at that rate of interest is equalto the amount of saving at that rate.

The above is not to be found in Marshall’s Principlesin so many words. Yet his theory seems to be this,and it is what I myself was brought up on and what Itaught for many years to others. Take, for example,the following passage from his Principles: “Interest,being the price paid for the use of capital in any

1 See the Appendix to this Chapter for an abstract of what I have beenable to find.

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