Interest Rate Fallacy

Economists and financial analysts often assume high interest rates are associated with tight monetary conditions and, conversely, low interest rates are associated with easy money. In reality they indicate the opposite because of the supply side of credit.

For example, with low interest rates, there needs to be willing providers (banks providing loans), but low interest rates implies low returns. That’s why there is a positive correlation between interest rates and actual credit issued—there is greater supply when interest rates go up because of better returns.

Milton Friedman’s interest rate fallacy says that lower interest rates are indicative of “tightening money” rather than “easy money”.

Read Milton Friedman’s Interest Rate Fallacy in Monetary Mechanics.

See also:

  • Interest Rates Are the Price of Time

    Author Edward Chancellor neatly summarizes why interest rates are so important, “Interest rates are the price of time.” Since time is a consideration in every financial transaction that makes up the economy, interest rates are a foundational concept to understanding behavior.

  • How Long Will a Recession Last?

    We are probably in a recession already, but we can’t know for sure for another quarter or so. With inflation on the rise and interest-rate hikes making less money available, it will be some time before things grow again.

  • Interest Enables Transactions Across Time

    Interest rates are a technology that allows people to transact across time. Without the concept of interest, it’s only possible for two parties to transact with what is immediately in front of them, in that very same moment.