G. L. S. Shackle, “Interest-Rates and the Pace of Investment” (1946/1955)

Shackle’s essay asks why a familiar theory of investment seemed to conflict with business testimony gathered by the Oxford Economists’ Research Group. The orthodox view says that a fall in interest rates raises the present value of future returns and so should make more investment projects worthwhile. Shackle does not reject this doctrine; he narrows it. Its force depends on how far into the future entrepreneurs can meaningfully value receipts, and on how heavily uncertainty discounts those receipts before the pure rate of interest has much work to do.

It was until recent years an accepted doctrine that changes of interest-rates powerfully influence the pace at which enterprisers, all taken together, extend or improve their equipment.

The formal argument begins from present valuation. A future receipt has to be reduced both because it is deferred and because it is doubtful. Shackle separates these two elements: pure time-discounting depends on the interest rate, while the allowance for uncertainty depends on the remoteness and reliability of the expected return. The investment decision turns on whether the entrepreneur’s current valuation of the expected net return exceeds the supply price of the instrument. A lower interest rate can therefore raise valuations and bring some marginal projects into being; this is the theoretical mechanism Shackle retains.

Thus the equivalent of $c$ in cash free from doubt or deferment will be $p = cs(x) e^{-\rho x}$.

Under certainty, the interest mechanism can be strong. A return expected far in the future is more sensitive to the discount rate than one expected soon; durable assets whose earnings stretch over many years therefore show high rate-sensitivity. This explains why the orthodox doctrine fits cases such as housing or other comparatively secure, long-lived assets. Where future income is dependable, a small fall in interest may substantially raise demand-price.

This elasticity increases numerically in direct proportion to the futurity $x$ of the net return, and the proportion in question is itself equal to the interest-rate.

The apparent contradiction arises because many business investments are not valued as long, secure streams. Managers often require very large margins over borrowing cost, and questionnaire replies suggest that ordinary variations in interest are too small to affect projects exposed to changing demand, invention, competition, fashion, and obsolescence. Shackle interprets these replies not as a refutation of valuation theory but as evidence that uncertainty sharply truncates the economically relevant life of many capital goods.

The decisive point is that risk is not merely a fixed deduction from expected receipts. If uncertainty grows with futurity, it falls most heavily on the very distant returns whose present value would otherwise be most interest-sensitive. Shackle’s illustrative formulation makes the risk coefficient decline exponentially, so that a “marginal rate of risk” is added to pure interest. When this risk component is large, a one-point movement in the pure rate changes the total discount applied to conjectural earnings only slightly. Investment then appears insensitive to interest because uncertainty has already absorbed the distant future.

This also explains the psychology of business testimony. Entrepreneurs notice changes in orders, markets, taxation, costs, and technical prospects more readily than small movements in a relatively stable borrowing rate. A rate change may still alter a calculation, but not enough to become the remembered or reported cause of a decision. Interest is often part of the background against which plans are made, rather than the foreground event that revises them.

Shackle’s conclusion is therefore conditional rather than iconoclastic. He preserves the classical link between interest and investment where future returns are secure and long-lived, but denies that it can be generalized to all capital formation. The pace of investment depends on the distribution of projects near the margin, the expected life of their returns, and the severity with which uncertainty discounts remote prospects.

The most realistic simple assumption is, however, that the instrument is expected to yield uniform net returns for some finite number of years and then be abandoned.