Chapter 6

Thinking About Interest Rates

IN THIS CHAPTER

Understanding interest rates and trading through time

Discovering the role of interest rates in pricing bonds and stocks

Reconsidering nominal versus real interest rates

Understanding how monetary and fiscal policy affect interest rates

If you have a mortgage, car loan, student debt, or even a credit card, chances are you’re familiar with interest rates and interest payments. In many ways, they are the worst part of borrowing because they reflect an extra payment you have to pay beyond the principal amount originally borrowed. They’ve been the subject of debate and commentary for a long time.

The Old Testament Book of Ezekiel clearly proclaims the charging of interest as a sin. Aristotle condemned interest payments and called them “the most unnatural” form of increasing wealth. Islamic tradition frowns on interest as riba, or usury. And Karl Marx viewed the interest rate as a measure of labor exploitation. He looked forward to the final revolution when the proletariat would rule and the interest rate would fall to zero. In short, even outside of macroeconomics, this has been a topic of, well … considerable interest.

Macroeconomists have thought a lot about interest rates, too. Interest rates play a key role in consumer spending and business investment decisions. They’re also critical to the workings of both monetary and fiscal policies. And any understanding of the financial markets has to include some notion of how interest ...

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