Journey in Learning of Economics Part 5

Having dealt in quite some detail about the labour and the goods market, it is the time to shift focus on the Finance Market, aks money market. Like these two markets this one is also equally susceptible to the laws of supply and demand. The good in this market is the money and the price interest.

                       Why interest? Interest has been religiously considered wrong by some religious traditions. Since Jews did not have any religious proscription, at least in European countries, they have been traditionally involved in the business of loaning money and charging interest. It might have been one of the reasons as to why they became object of unreasonable hatred in some circles. I say unreasonable, because there is apparently nothing wrong in charging interest upon a loan. Firstly, the person advancing a loan is taking a risk of default and losing his money. This risk is reason enough for the consideration of interest. Secondly, the person advancing loan is delaying immediate gratification. That is, he is postponing his use and enjoyment of money. Interest is his award for this. Thirdly, he might have used this money to buy some capital and fetch some more money. He did not get an advantage from the money, because he advanced the same to some other person. The other person used the savings of some one else and perhaps used them to get rich. It is but justice that he should pay some portion of the benefit accrued to him to this other person. 

                     When the rate of interest falls, i.e. the price of the loan decreases, as expected, no. of people willing to get the loan increases and thus demand increases. Similarly when rate of interest increase, the supply of the same increases because advancing money on the loan appears as lucrative and profitable deal. However, savings do not increase by increase in interest rate of the banks. Rather one kind of saving tend to become the savings upon which higher interest is available. Saving is thus a function of, habits, culture and laws. If suppose employers are mandated to deposit one part of the income of their employees in their provident fund, the total amount of saving would go up. Similarly if the long term savings are more profitable and exempted from income tax, though the total amount of saving would not increase in the economy, but the proportion of long term savings would increase. Long term savings provide long term certain base for advancing loan, which is good enough even in absence of increase in total amount of saving. 

               Interest rates to firm would also depend upon, risk involved. Firms raise money by issuing bonds or shares. Shares are actually ownership of the firms. Bonds are certificate of money received. If one is getting a high interest rate, the bond would be less secure and less liquid. Thus interest rate depend upon liquidity and  risk involved.


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