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Report No. 63

2.5. Variations on above approaches.-

Modern economic analysis has added variations to these basic approaches.1 John Maynard Keynes (1883-1946), for example, has argued that interest stems directly from the supply of and demand for money itself, rather than the use of money. His theme is that "liquidity" is the unique characteristic of money, and he called the demand for money to hold "liquidity preference".

The concept of "liquidity of money" has been developed by an English economist:2

"To develop a more refined theory the motion of liquidity preference, measured by the reward required to induce owners of wealth to hold assets other than money, must be broken up into a number of aspects. Amongst the disadvantages of various kinds of assets compared to money we may distinguish:

1. Liquidity in the narrow sense.-Liquidity partly consists in the capacity of an asset to be realised In money. A limited and imperfect market, the cost and trouble of making a sale, and the time required to effect it, reduce the liquidity of an asset quite apart from variability in its price. Liquidity in the narrow sense depends upon the power to realise its value in cash, whatever the value may be at the moment. To avoid confusion with Keynes' language we will call this quality "convenience" instead of "liquidity".

2. Uncertainty of future capital value or capital-Uncertainty for short, due not to any fear of failure by the borrower, but to the possibility of changes in capital values owing to changes in the ruling rate of interest. (This is the main ingredient in Keynes' conception of liquidity preference. He regards the rate of interest primarily as a premium against the possible loss of capital if an asset has to be realised before its redemption date).

3. Lender's risk-This is the fear of partial or total failure of the borrower. Further, when comparing long term bonds with other paper assets, we have to add one more factor.

4. Uncertainty as to the income-that a sum of money now committed to the asset will yield in the future, or income uncertainty, (for short)."

It was not, however, without long controversy that the economic justification for charging interest came to be accepted.

1. William Kinnard Jr. (University of p. 191. Connecticut), Article on Interest, in Encyclopaedia Americana, Vol. 15,

2. John Rebinson, The Rate of Interest and other Essays (Macmillan, London, 1952), p. 6.

2.6. In this context, the long controversy surrounding usury and the usury laws is of historic and economic interest. The primary object of usury laws is to prevent the exploitation by the lender1 of the need of the individual borrower, as seen in contrast with prevailing conditions.


is the charging of interest in excess of that allowed by law for a loan of money or for the extension of the maturity of a debt. In early English law, usury meant compensation for the use of money regardless of amount. But the above is the present understanding. In the Encyclopaedia Britannica,2 it is stated:-

"The laws against usury are of ancient origin. Early laws of China and India prohibited usury. The Mosaic law limited the exaction of interest; the Roman law prescribed or regulated such charges. In England, during the middle ages the practice of charging interest was maligned by the church and outlawed by the State. But the credit requirements of modern commerce caused removal of these restrictions in England and elsewhere.

While the exaction of oppressive interest is not illegal under the common law of England or the United States, a public policy which protects debtors from over-reaching lenders has been implemented by the statute law of both countries. In England, the Money-lenders Acts of 1900 and 1927 constituted a code providing for registration of money-lenders, governing the form of their contracts, limiting rates of interest and providing for the reopening by the court of money-lending transactions."

1. See para. 2.2, supra.

2. Encyclopaedia Britannica, Vol. 22, p. 908.

Interest Act, 1839 Back

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