THE THEORY OF INTEREST

than all they, or their predecessors, lost in the previousperiod. The tremendous fall in prices in 1920 and 1921boosted the real interest rate above 15 per cent. Thusthe computed real rate is exceedingly erratic during aserious inflation or deflation.

Chart 44 represents in a different way the same theo-retical relationship between price change and the rate of

p p' = 10 ? I

- —.1 - $

P’ = o.P' = o 0

P' f -5? - 5

—■-Pries Changes- 1 - ^ 10 % ■ ■■— -.10

--1 U Lis

15 I i = 15?

10 -Liiai--f——

i = 5£ Assumed Hormal Rate

5 " . r ———— 1 r

0---i-=-2---

t 5-Interest Rates--- 1 1 = 1 --:

.10 -J-J- ; ------J—-rr-

CHART 44

Theoretical Relation of Price Changes ( P') and Interest Rates (i).

interest as that depicted on Chart 43. In Chart 44, pricechange ( P') is represented not by the slope of a line, butby distance measured above or below the zero line. Thuswhen the price level is rising at the rate of 5 per cent perannum, P' is represented by a horizontal line 5 per centabove zero. When prices are stationary, P' drops to zero,and so on. If men had perfect foresight, they would adjustthe money interest rate so as exactly to counterbalance

r 414 ]

P' = 5*

P' =

10?

V

II

o

p< = o

p* 3 -si

P' = -10*

1

i = 10 ?

i =

15 ?

1 = 6 *

Assume

1 Normal R

ite

1 =0

i = - 5 *

__

CHART 44