On Money and the Interest Rate

David Fields (guest blogger)

A capitalist economy is a monetized production system, that is, economic activity is predicated upon the extent to which financial institutions extend credit to enterprises. Consequently, output expansion is mediated by the mechanisms of banking. The ability of firms to acquire necessary labor and material inputs, essential for fulfilling profit expectations and enabling wage disbursements to workers, is contingent upon the scope of debt obligations. Credit, thus, functions as a social technology of deferred payment and settlement, establishing a relatively secure contractual claim that enables entrepreneurs to address uncertainty and facilitate long-term operational expansion, as determined by the level of aggregate demand. Restrictions on credit invariably nullify attempts at increased production. Banks facilitate the prepayment of firms for capital goods and labor costs, sustaining production and distribution prior to the realization of profits from projected consumer goods sales.

Proportional shares of accumulated profits are transferred to the banking sector. Firms are obligated to deduct interest payments from their collateralized deposit schedules of future revenue. This is called the reflux mechanism, or monetary circuit, which can be represented by the following Marxian schema:

                                                           M* – M – C’ – M’ – M*’

where M* denotes bank loans to firms that enable the production process (M – C’ – M’), ultimately converted into M*’, representing interest payments to the financier from realized profits, M’. The difference (M' - M), profit, is regulated by the financial provisions offered by banks , which are subject to the interest rate is set by a nation's central bank. Hence, the interest rate is a conventionally determined distributive variable that ultimately determines the proportional allocation of income.

Consequently, should the central bank implement and sustain elevated interest rates over extended duration while aggregate demand remains subdued due to insufficient fiscal policy, a decline in real wages will ensue, unless there is effective labor resistance. In this sense, what can be defined as monetary austerity sacrifices long-term productive investment, unless there is an effective counter-cyclical fiscal space, which is limited for states that faces balance of payments constraints.