THE THEORY OF INTEREST

preciation. The inadequacy in the adjustment of the rateof interest results in an unforeseen loss to the debtor, andan unforeseen gain to the creditor, or vice versa as thecase may be. When the price level falls, the interest ratenominally falls slightly, but really rises greatly and whenthe price level rises, the rate of interest nominally risesslightly, but really falls greatly. It is consequently of theutmost importance, in interpreting the rate of intereststatistically, to ascertain in each case in which directionthe monetary standard is moving and to remember thatthe direction in which the interest rate apparently movesis generally precisely the opposite of that in which itreally moves.

It should also be noted that in so far as there exists anyadjustment of the money rate of interest to the changesin the purchasing power of money, it is for the most part(1) lagged and (2) indirect. The lag, distributed, hasbeen shown to extend over several years. The indirectnessof the effect of changed purchasing power of moneycomes largely through the intermediate steps which affectbusiness profits and volume of trade, which in turn affectthe demand for loans and the rate of interest. There isvery little direct and conscious adjustment through fore-sight. Where such foresight is conspicuous, as in the finalperiod of German inflation, there is less lag in the effects.

§2. The Six Principles

But the more fundamental theory of interest presup-poses a stable purchasing power of money so that thereal and nominal rates coincide. In that case the rate istheoretically determined by six sets of equations or con-ditions: the two Opportunity Principles; the two Im-patience Principles; and the two Market Principles. The

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