Natural Interest Rate, Money Rate of Interest, and the Fluctuations of the Business Cycle

In conformity with Wicksell’s terminology, we shall use “natural interest rate” to describe that interest rate which would be established by supply and demand if real goods were loaned in natura [directly, as in barter] without the intermediary of money. “Money rate of interest” will be used for that interest rate asked on loans made in money or money substitutes. Through continued expansion of fiduciary media, it is possible for the banks to force the money rate down to the actual cost of the banking operations, practically speaking that is almost to zero. As a result, several authors have concluded that interest could be completely abolished in this way. Whole schools of reformers have wanted to use banking policy to make credit gratuitous and thus to solve the “social question.” No reasoning person today, however, believes that interest can ever be abolished, nor doubts but what, if the “money interest rate” is depressed by the expansion of fiduciary media, it must sooner or later revert once again to the “natural interest rate.” The question is only how this inevitable adjustment takes place. The answer to this will explain at the same time the fluctuations of the business cycle.

--Ludwig von Mises, The Causes of the Economic Crisis: And Other Essays Before and After the Great Depression, ed. Percy L. Greaves Jr., trans. Bettina Bien Greaves and Percy L. Greaves Jr. (Auburn, AL: Ludwig von Mises Institute, 2006), 107-108.