There Is a Market Rate of Interest

The supplied file is a short standalone economic policy essay. Hans F. Sennholz argues, in a distinctly Austrian idiom, that interest is not a policy variable to be “set” without consequence but a market price coordinating present and future uses of capital. The essay moves from a historical note on political hostility to interest, to a conceptual account of the market rate, to a critique of Federal Reserve credit expansion and its bubble-producing effects.

Sennholz begins by placing interest under the long history of political intervention. Governments, religions, and central banks have treated lending charges as morally or administratively suspect, while rarely allowing them to emerge from exchange itself. Against this, he frames interest as one of the indispensable signals of economic calculation.

In a free economy, interest rates play a role similar to those played by prices and wages.

This comparison is central: interest guides action across time. It tells entrepreneurs whether scarce capital should support present consumption or longer production aimed at future satisfaction. The essay’s core conceptual move is to define the market rate not as an arbitrary number but as a composite expression of time preference, monetary depreciation, and debtor reliability.

The market rate of interest is a gross rate usually consisting of three distinctive components: the pure rate, the inflation rate, and the debtor's risk premium.

The “pure rate” rests on mortality and time preference: future goods are valued less than present goods. The inflation component reflects currency depreciation, and the risk premium reflects the borrower’s trustworthiness. This tripartite account lets Sennholz distinguish a genuine market rate from a central-bank-administered rate that may imitate the form of interest while falsifying its informational content.

His target is the Federal Reserve, whose mandate and practice he sees as subordinating market coordination to political doctrines of employment and income stimulation.

Its policies are guided by popular doctrines calling for stimulation of national employment and income.

For Sennholz, the problem is not merely that the Fed chooses the wrong rate, but that any rate diverging from the market rate misdirects producers and consumers. A rate above the market rate contracts credit; a rate below it expands borrowing without corresponding saving. He writes in the immediate context of very low early-2000s rates, connecting them to surging household, federal, and foreign-financed debt. The result is an artificial prosperity that mistakes borrowing and asset appreciation for wealth creation.

Such credit expansion, unsupported by genuine savings and capital formation, generates illusionary gains making people believe that they are more prosperous than they actually are.

The essay’s theory of the boom follows from this: cheap credit raises stock and real-estate prices, encourages consumption out of paper gains, and draws entrepreneurs into projects not justified by real saving. Sennholz therefore interprets the boom itself as capital consumption masked by rising asset values. The later downturn is not an accidental failure of confidence but the market’s forced correction of earlier falsified signals.

But, in the end, there is general impoverishment.

The closing section sharpens the warning. Housing, equities, and trade imbalances are treated as connected symptoms of the same monetary error: the suppression of the true coordinating rate of interest. Sennholz’s relevance lies in this insistence that financial instability is rooted not only in speculative psychology but in institutional distortion of price signals. The essay ends by restating its thesis in political form: central bankers may ignore the market rate, but they cannot abolish it.

The Federal Reserve is doggedly ignoring the market rate of interest which alone represents the judgments and preferences of the people.