A History of the Relationship Between Interest Rate and Profit Rate in Heterodox Approaches

Abstract

This article seeks to understand, compare, discuss and systematize the theories on the causal relationship between the rate of interest and the rate of profit, as proposed by various authors, while highlighting their similarities and differences. One group of authors asserts that the rate of interest determines the rate of profit, and thus the distribution of income, while a second argues that once the distribution is determined, it is the rate of profit that governs the rate of interest. This attempt to analyze and systematize the main approaches forms a significant first step in understanding contemporary finance.

Keywords:

• Interest rate
• profit rate
• finance
• Marx
• imperfect competition

JEL CLASSIFICATIONS:

• E43
• B12
• B14
• B51

Acknowledgments

Part of this paper was presented at the “Webinars: Post-Keynesian Economics and Macroeconomic Modelling”, Post-Keynesian Economics Society (PKES) and Italian Post-Keynesian Network (IPKN), 06/24/2021. This paper was also presented during the (ESHET) ‘23rd Summer School in History of Economic Thought, Economic Philosophy and Economic History “Economics in relation to other disciplines: history and perspectives”’, 09/02/2021. The author wishes to thank the participants in the webinar and the summer school, and in particular discussants Orsola Costantini, José Luís Cardoso, Jean-Sébastien Lenfant and Richard Arena for their helpful comments. Furthermore, the author wishes to thank Roberto Ciccone, for valuable advice and suggestions, and two anonymous referees. Any errors or omissions are of course the sole responsibility of the author.

Notes

1 See Panico (1983, 33–57), in particular page 46; Pivetti (1987a, 1987b).

2 From the first word of the title in the original language.

3 “Rent, interest, and industrial profit are only different names for different parts of the surplus value of the commodity, or the unpaid labour enclosed in it, and they are equally derived from this source and from this source alone.” (Marx [1865] 1995, MIA).

4 Basically, placing the banking sector within the well-known Marxian diagram money—commodity—money, the result is: M→M →C→M'→M''. With M = money, C = commodity, M < M'' < M'. Money passes from the hands of the financial capitalist to those of the productive capitalist, but still remains money (M→M). The latter uses the money to produce goods (M →C) which he sells, obtaining more money than at the beginning (M → M'). Part of this money finally goes to the financial capitalist (M'→ M''). See Marx [1894] 1996.

5 See Panico (1988).

6 “Marx admitted that there is a tendency for these two rates to move together, although he kept trying to diminish confidence in such a tendency.” (Panico 1988, 59). See also Pivetti (1987b).

7 Hilferding ([1910] 1981) takes up Marx’s analysis: the interest rate is a part of the profit rate, which is its ceiling, and the level of the interest rate depends on the supply and demand for credit (Hilferding [1910] 1981, 110). The struggle between sub-classes of capitalists and the institutional factors, which are present in Marx’s analysis, are not discussed by this author.

8 Some pages from Marx ([1905–1910] 1971) are particularly interesting: 461–462, 471, 480, 497, 499, 505, 508–513.

9 See Pivetti (2002). It is also worth mentioning the criticism of the possibility of constructing monotonically decreasing demand curves of production factors as their remuneration varies: among others Robinson (1953); Sraffa (1960); Pasinetti (1966); Garegnani (1970); as well as more recently Fratini (2015, 2019a, 2019b).

10 See also Fratini (2020, 98 footnote 13), and Wicksteed (1910, 573), as cited in Fratini (2020).

11 It should also be remembered that Keynes criticises the traditional marginalist approach to the interest rate and states that this rate brings the money market into equilibrium, and full employment and investment savings with great difficulty (practically insurmountable in his thought) (Keynes 1936).

12 “Rather, as Keynes insisted, the marginal efficiency of actual investment projects is governed by the interest rate charged for the loan of money.” (Moore 1988, 261).

13 This part of the Keynesian approach is as sensitive as the rest of the marginalist theory to the criticisms mentioned above concerning the theory of value (see footnote 9). For some authors (including Marglin 1970; Pasinetti 1974; Vickers 1992; Samuelson and Nordhaus 1985), instead, Keynes’ approach could be developed through a different approach called array of opportunities, but this approach too has been widely criticised (among others, Ackley 1978, 620–624; Petri 2004, 262–268; Di Bucchianico 2021, 13–15).

14 See also Hodgson (1981), a first attempt to introduce the monetary sector into the Sraffian system.

15 In addition, some other references to this hypothesis are worth mentioning: Sylos Labini (1971); Garegnani (1978–1979); Vianello (1985); Roncaglia (1988); Schefold (1989).

16 See Pivetti (1985, 73) as well as Pivetti (1991, 3–4).

17 See also the debate between Nell (1988), Wray (1988) and Pivetti (1988) in Political Economy. In addition, it is worth noting the comment of Ciccone (1990) who criticises the fact that the variable that should determine the distribution is the real interest rate and not the monetary rate. The central bank can influence the real interest rate through the nominal interest rate, but it is doubtful that the real interest rate can be controlled by the central bank. The real interest rate depends on the nominal interest rate, but also on inflation. However, in Pivetti’s model, inflation results from the distributional effects of interest rate changes. If, therefore, the real interest rate depends on inflation and inflation depends on the real interest rate, the reasoning becomes circular. A response to this criticism can be found in Pivetti (1991, 52–54). Finally, Serrano (1993) discusses this issue, not finding the response of Pivetti (1991), too convincing. Furthermore, Ginzburg and Simonazzi (1999) hypothesize an indirect mechanism by which the interest rate influences production costs through the relationship between the interest rate and raw material prices.

18 More recently, Panico, Pinto, and Anyul (2012) returned to the topic with an article dealing with the relationship between the financial sector and distribution, in particular the effects of household loans on consumption and aggregate demand.

19 Following the Marxian diagram outlined above (see footnote 4), only the first and fourth steps touch the money capitalist, i.e., steps M→M and M'→M''. The bank, however, intervenes in each step, but performs other functions and facilitates the transformation cycle between capital-goods and capital-money.

20 See Panico (1988, 87): “Thirdly, they advance capital to those industrial capitalists who require it in industrial activity. Only this third function corresponds to that performed by the money capitalists in the analysis described above. It is only in this case that the bankers make available new capital to the industrial capitalists. In the other two cases, the bankers only transform revenues or capital already in the hands of the industrial capitalists from a less liquid to a more liquid form.” See also (ibid., 92–93).

21 On this subject, see Mongiovi and Rühl (1993, 93–94). In addition, it is extremely interesting the analysis of Barba and De Vivo (2012) who distinguish “a stricto sensu technique of production and a wider definition of it” (Barba and De Vivo 2012, 1485): the use of circulation coefficients, like the financial ones, is acceptable only in the wider definition of the technique of production (see also, Steedman, 1977, 112–115).

22 See Dvoskin and Feldman (2021).

23 Obviously, it is more convenient to use the money by investing in production and getting the normal rate of profit, rather than accumulating it in deposits. But the theoretical problem remains.

24 In the 1980s and 1990s the subject of the relationship between the interest rate and the profit rate has been discussed too. Within the Marxian framework, Pegoretti (1983) elaborated the theory of the tripartite distribution, whose shortcomings Gattei (1983) immediately highlighted and attempted to correct. The critique of Panico and Pivetti's models is enriched by the criticism of Pasinetti (1988) as well as by the doubts about the basic approach expressed by Robinson (1979), Bhaduri and Robinson (1980), Mongiovi and Rühl (1993) and Ciccarone (1998) who develops an alternative model to Panico's one of monetary determination of distribution. However, this last model presents problems in the assumptions about the structure of rates, since it assumes a proportional relationship between the rate on deposits and the rate on loans. This implies that, as rates vary, their difference also varies proportionally; this does not seem to correctly describe the functioning of the banking system. Moreover, in Ciccarone's model the distributional contrast may be mitigated by the variation of the deposit rate in the opposite direction to that of the real wage, a phenomenon whose relevance for the distribution could be dubious. Finally, Franke (1988) develops his own model. See also Dvoskin and Feldman (2021) on the models of Panico, Pivetti, Franke and Ciccarone; in their analysis a necessary and sufficient condition for a monetary theory of distribution is that the interest rate can be considered as the opportunity cost of real activity.

25 Two main approaches are identified in the post-Keynesian framework, the horizontalist approach, according to which the money supply curve is horizontal (with the interest rate in ordinate and the quantity of loans in abscissa) and the interest rate is set exogenously by the central bank, and the structuralist approach, according to which the money supply curve is upward sloping and the interest rate is an endogenous variable (see in the most recent literature Deleidi 2020).

26 The post-Keynesian structuralists, who consider the money supply curve to be increasing rather than horizontal, consider the volume of credit granted (and reserves demanded) to be relevant in determining the interest rate. They base this idea on the application to the banking sector of the theory of increasing risk and the theory of liquidity preference (for a more detailed discussion see, among others, Deleidi 2020).

27 Variations in the distribution due to variations in demand concern possible relations in the economy as a whole, but are outside the direct relationship between the profit rate and the interest rate that is the subject of this study. Moreover, the criticism to this school of thought by Vianello (1985); Ciccone (1986); Kurz (1990); Garegnani (1992), revolves around the relationship between the desired degree of accumulation and the profit rate.

28 See also Cingolani (2011) and Bellino (2019) about this approach.

29 Pasinetti (1981, 174): “Yet, both the concept of a natural rate of profit and the concept of a natural rate of interest emerge from precisely the same approach to economic reality. The former stems from the principles that all prices be proportional to physical quantities of labour (a labour theory of value); and the latter stems from the principle that all individuals, when they engage in debt/credit relations, should obtain, at any time, an amount of purchasing power that is constant in terms of labour (a labour theory of income distribution). And the two labour theories imply each other.

The difference comes from their expressing the same basic principles within two separate spheres of economic activity. The rate of profit pertains to the sphere of production, which, in a natural economic system, is complete in itself and does not need any financial transaction to achieve self-sustained growth. The rate of interest pertains to the sphere of consumption and of the needs of individual consumers to transfer personal consumption and the needs of individual consumers to transfer personal consumption through time. This sphere too is complete in itself, and all inter-personal borrowing and lending must cancel each other out for the economic system as a whole, quite independently of what is happening in the sphere of production.”

30 Pasinetti (1981, 144): “The reader will realise, however, that they [the results] are in sharp contrast with the interpretation of wages and profits, and of their movements in time, that the whole of economic theory (both Classical and neoclassical) has given so far”.

31 See also Hein (2002b).

32 See also Argitis (2001).

33 See also Shaikh (2011) where a preliminary analysis of the 2016 study is presented.

34 See also Toporowski (2018).

35 This idea about interest and profit rate is actually closer to that of Tooke and J. S. Mill than to Marx’s approach. Toporowski (2020, 469, 471, 473) assert that capitalists give and borrow money from each other through the intermediation of the bank. Hence two subclasses of capitalists cannot be identified. Moreover, this approach (different from both the classical economists and Marx opinions) does not seem compatible with the theory of endogenous money (according to which the bank does not lend deposits, but creates loans).

36 See Hilferding ([1910] 1981).

37 However, the question arises as to which of these transactions are actually characteristic of traditional banking (see DeYoung and Rice 2004a, 2004b). Moreover, it can be observed that fees on some types of banking services are often assimilated to deposit rates, as stated by ECB (2020, 65).

Additional information

Notes on contributors

Riccardo Zolea

Riccardo Zolea is a PhD candidate at the University of Roma Tre in Rome, Italy. Riccardo can be contacted via email at: [email protected].