Redeeming Economics (12) Interest

In his book Redeeming Economics, John D Mueller has some interesting insights on the issue of interest. The scholastic economists were opposed to interest. Mueller explains the reason. They had adopted an assumption from Aristotle that economic growth does not take place. Based on their experience, this assumption seemed quite reasonable.

They adopted Aristotle’s assumptions that the population and its average standard of living does not increase—because mankind in general had never experienced a substantial and sustained increase of either. One reason they had not increased was that the average length of a human life had not increased… Average life expectancy in England in the fourteenth and early fifteenth centuries—twenty-four years—was about the same as it had been in the Roman Egypt…. Twenty-four years is too short for the average person to acquire much human or nonhuman wealth, so per capita real income was close to the subsistence level, and average annual real economic grow during the whole period was approximately zero (p.34).

This assumption was a weakness in their economic theory. When the standard of living began to grow during the mid-sixteenth century, they could not explain it. It also affected their understanding of interest.

The scholastic assumption that economies did not grow was directly relevant to the controversy about interest and usury… The scholastics carefully analyzed the components of interest and resolved them into three: the risk of loss (damnum emergens) when the borrower defaults or repays the loan in depreciated money; the opportunity cost of forgoing income from alternative investments (lucrum cessans); and the pure interest (interesse) excluding these factors. A consensus allowed for the charging of interest to compensate for risk of loss, but it did not allow charging pure interest, while there was disagreement about whether it was right to expect compensation for opportunity cost.

A stagnant economy, the kind the early Scholastics routinely assumed, rarely produces aggregate business profits, because new production at best replaces goods consume directly and the human and nonhuman capital used up in the process (p.35).

Mueller suggests that the reason the Scholastics objected to pure interest was empirical rather than moral. They believed it was impossible to get a return on an investment, so pure interest could not exist. If someone was able to get a return, it was because they were exploiting other people.