Frank Albert Fetter, Interest Theory and Price Movements

Frank Albert Fetter’s journal article, originally published in 1927 and reprinted in 1977, connects the theory of interest with monetary change, banking policy, and the business cycle. Its three parts reconstruct the history of the interest problem, develop a general theory of time-valuation and capitalization, and apply that theory to changing prices. Fetter’s central claim reverses the familiar explanation of capital values through an interest rate independently established in lending markets: time relations already permeate the valuation of goods, and contractual interest emerges from this wider price system. The essay seeks cooperation between theoretical economists and statistical investigators, arguing that measurements of prices and rates require a coherent account of what those relationships mean.

The historical survey distinguishes successive conceptions of interest without treating them as a straightforward progression toward truth. Hume displaced the popular belief that abundant money necessarily produces low interest with an explanation emphasizing abundant riches. Yet Fetter finds in Hume’s discussion of borrowing, consumption, and frugality psychological possibilities obscured by subsequent interpretations. Turgot’s account of land valuation similarly suggests that capitalization can arise through buyers’ and sellers’ choices without borrowing a discount rate from the loan market. Senior’s abstinence theory brought deferred enjoyment into view, but confused personal conduct with productive instruments and never developed its implications systematically.

These promising insights were constrained by the division of productive factors into land, labor, and artificial capital. Associating rent exclusively with natural agents and interest with manufactured agents made a general explanation of temporal valuation difficult. Fetter credits Böhm-Bawerk with recognizing the importance of time and Clark with recognizing capital’s value dimension and extending it to land. Both nevertheless reverted, in his judgment, to productivity explanations grounded in the origins of goods rather than their anticipated uses. Physical productivity can explain quantities of output; it cannot by itself explain a percentage return on an asset whose purchase price also requires explanation.

Part II reconstructs the argument from individual choice through barter, monetary exchange, and durable-property valuation. Time-preference precedes organized lending: people choose between differently timed satisfactions even without markets. Such choices depend on scarcity, anticipated needs, habits, training, and social institutions, rather than an invariant preference for every present commodity.

Time-value is not a quality separate and apart from the total value of a concrete object (wealth) or of a specific act (labor); it is merely that part of the total value which in the particular circumstances is due to time relations, just as other parts of the value may be logically attributable to conditions of place, stuff, form, proprietorship, and manifold subjective factors in men.

This formulation allows future goods to command greater value in particular circumstances: seasonal usefulness matters. Exchange nevertheless brings divergent individual valuations into closer alignment. Storage and other means of shifting goods through time connect successive price systems, while deterioration, labor, and preservation costs prevent complete equalization, much as freight costs sustain geographical price differences.

Durable agents extend this reasoning because they contain a succession of future uses. Their present prices reflect both the anticipated value of those uses and their distribution through time. Capitalization need not begin with an investor consciously consulting an interest table; an implicit discount can emerge through customary practice, competition, and trial and error.

This phenomenon of discount of uses contained in any agent or source of incomes is correlated not with artificiality but with durability of the income bearer, because durability means continuance through time, and more or less extended periods between the present valuation and the maturity of the future use, product, or income, that is taken to be one of the constituent parts of the present agent.

Land thus belongs within the same explanation as machinery. Normal investment profit arises as previously discounted future uses approach realization. Unexpected changes in earnings lead to recapitalization, helping explain the tendency toward equal returns without making production costs the governing cause of asset values.

Thus profits no more explain interest than interest explains profits.

Both are traced to time-discounts embedded in prices. Fetter nevertheless rejects the notion that this produces one uniform observable rate: risks, costs, security constraints, and imperfect transfers sustain differences among markets.

Part III distinguishes monetary disturbances from changes originating in time-preference. Anticipated inflation or deflation can produce compensating contractual rates, but adjustment is delayed and uneven, leaving outstanding contracts exposed and disrupting investment. Crucially, newly produced money or government paper enters circulation as payment, whereas expanding bank credit first enters as loanable purchasing power. Credit inflation can therefore sustain rising prices alongside low discount rates, stimulating further borrowing until reserve constraints intervene.

Fetter’s policy argument follows from this distinction. Competitive banks pursuing earnings can collectively intensify fluctuations that no individual bank has an incentive to restrain. Publicly controlled central banking offers a means of moderating this process.

The index number, not the reserve percentage, might better be the compass by which to guide the discount policy of the great central, noncompetitive bank.

This proposal is bounded: credit control may restrain shorter cyclical movements but cannot indefinitely override the forces governing the monetary standard. Fetter accordingly criticizes Wicksell’s unlimited cumulative price movement as dependent on unreal banking assumptions. Wartime borrowing and postwar reconstruction further demonstrate that rates cannot safely be suppressed against underlying scarcity and deferred-maintenance needs. The article’s enduring conceptual contribution is its integration of interest into general price formation; its practical ambition is to distinguish genuine stabilization from policies that disguise resource constraints through cheap credit.