A new semester has started at N.C. State University, with many students eager to learn about economics. Dr. Mike Walden, a professor of agricultural and resource economics, explains what he teaches these students about interest rates.
“Well …, oftentimes you hear it stated that the interest rate is simply the cost of money. Now that’s… close. You almost get … a prize for that answer, but technically it’s not correct. Really what the interest rate is, is the cost of having resources now rather than having resources later.
“Now the reason people often say it’s the cost of money is because we typically measure resources in terms of money. But, of course, we don’t have to. For example, I could make a trade with you where I say …, ‘Loan me your car and let me drive a thousand miles this year, and in exchange I’ll give you my car next year and you can drive 1,100 miles.’ That would actually be an implicit interest rate of 10 percent for me to have you transfer those thousand miles to me.
“So … if you think of interest rates in terms of giving up resources in the future in order to have more resources now, I think it puts that concept into perspective and really allows you to think through that process of making decisions about how to spend resources much more clear.”