Frank Albert Fetter, Interest Theories, Old and New

Frank Albert Fetter’s 1914 journal article, reprinted in 1977, defends the capitalization theory of interest against technological explanations and against compromises between productivity and psychological theories. Its immediate occasion is the controversy among H. R. Seager, Irving Fisher, and H. G. Brown. Fetter argues that this controversy obscures the decisive question: not how productive agents generate income, but why their prospective incomes are valued below their eventual worth. Contract interest reflects this prior discounting of future uses in the prices of durable goods. Explaining interest therefore requires a general theory of valuation through time, rather than a separate theory of the productive powers of manufactured capital.

The article’s eight sections move from Fisher’s apparent concessions to productivity theory through the origins and positive formulation of Fetter’s alternative, then examine time-preference, productivity, the capital concept, and Brown’s eclectic position. The opening criticism is directed partly against an apparent ally. Fisher had sharply rejected physical productivity as an explanation of interest, yet his reply to Seager presents the technical element as a cardinal feature of his theory. Fetter grants that acknowledging productivity need not entail a productivity theory; nevertheless, Fisher’s reaffirmation that nature’s productivity is an additional cause of interest makes his position seem unstable. The issue is whether production supplies the incomes being valued or independently explains their discount.

Fetter’s reconstruction of his writings from 1900 onward establishes both his claim to priority and the conceptual setting of capitalization theory. Interest belongs within a unified account of distribution: immediately enjoyable goods are valued as satisfactions; durable goods are valued through their services; nonsynchronous satisfactions and income streams are compared through present valuation. Productivity is consequently treated before time-value, without being made its determining cause. Fetter reserves “interest” for contractual payments on money loans and uses “time-value” for the wider phenomenon often called economic or implicit interest.

The canon of priority in economic reasoning applied here: whichever of two interrelated problems or mutually acting forces can be thought of as existing without the other, must be primary in the explanation.

This test reverses the customary sequence from an established interest rate to the discounted value of capital. People can choose between present and future uses without money, lending, or explicit percentage calculations. Capitalization likewise occurs whenever a durable source of future services receives a present valuation. Fetter’s examples of primitive accumulation and Crusoe’s choices show that an implicit scale of time-values need not originate in a credit market. An arithmetic discount rate expresses the valuation already made; it does not cause that valuation.

The rate of interest (contractual) is the reflection, in a market price on money loans, of a rate of capitalization involved in the prices of the goods in the community.

The explanatory order runs from individual choices concerning time, through the prices of goods embodying future incomes, to the market rate on loans. This is why Fetter objects to Fisher’s practice of beginning with an existing money-market rate and subsequently adjusting individual preferences to it. He also rejects “impatience” as a sufficient psychological description. Time-preference encompasses saving, patience, future provision, and preferences for later goods as well as eagerness for immediate enjoyment. Nor does every individual’s valuation converge exactly upon the market rate: security requirements, limited exchange opportunities, and imperfectly connected groups restrict adjustment.

The central criticism of Seager distinguishes physical productivity from two different value relations. Productive agents may increase output and thereby increase the value of goods available at a given moment. But this synchronous comparison does not explain the difference between an agent’s present purchase price and the future value of its products. Fetter’s diagram separates the physical-productivity/value-productivity relation from the temporal relation between capitalization and future income.

But if the future value of the products were not discounted, there could be no rate of interest.

A productive borrower can regularly pay interest because the price of the acquired agent already discounts its expected returns. Productivity theory begs the question when it calls this value increment “productivity” and then invokes it to explain interest. The entrepreneur is an intermediary who responds to valuation differences, not an independent source of the interest rate. Superior foresight and access to different markets may yield commercial profit beyond the time-related surplus; entrepreneurial activity also tends to equalize capitalization rates across goods and markets.

This argument requires abandoning the restriction of capital to “produced means of further production.” Land and orchards can be capitalized, bought with borrowed money, and yield returns on investment. Their valuation presents the same temporal problem as machinery. Fetter also disputes the assumption that production costs form an independently fixed foundation for capital prices: changes in productivity alter consumption-goods prices and are transmitted through valuations to agents, materials, and labor. Greater productivity can influence interest indirectly by improving present provision and reducing preference for present goods, potentially lowering rather than raising the rate.

Brown’s attempt to make productivity and impatience coordinate determinants reproduces, for Fetter, the same confusion: percentage “productivity” already presupposes the capital valuation it supposedly explains. The article concludes by distinguishing the competing positions and asserting the unifying reach of capitalization theory.

The capitalization theory, alone, is not eclectic, and explains interest on consumption and on production loans, in the same psychological terms.

The article’s significance lies in its insistence on a consistent explanatory sequence. Fetter acknowledges production, institutions, and entrepreneurial adjustment, but places them within the broader valuation process rather than alongside it as separate causes of interest. His psychological theory concerns the community’s valuation of future satisfactions, not simply the borrower’s personal impatience.