Reply To: Schumpeter and the zero rate of interest


The ERE is an imaginary construct used by economists to decompose net income into profit and interest. Interest is that part of net income that accrues to capitalist-entrepreneurs to compensate for their time preferences. They pay money to buy inputs before they receive money from the sale of outputs. Their saving-investing earn interest. Profit is that part of net income that accrues to the capitalist-entrepreneurs for their superior foresight. Those who more accurately anticipate the demands of consumers earn profit from their production decisions and those who less accurately anticipate consumer demands suffer losses.

To separate and analyze these two factors, economists pose the ERE. The ERE is constructed to eliminate uncertainty and therefore, profit. In the ERE, the patterns of demands are perfectly anticipated. Because of this, the profit that can be earned by reallocating resources toward more profitable and away from less profitable lines is exhausted. Although the ERE presents some philosophical puzzles, the absence of volition is not one of them. All that needs to be assumed is that the class of capitalist-entrepreneurs have perfectly accurate foresight about what other people will demand. This does not require that consumers be reduced to robots only that capitalist-entrepreneurs be elevated to demi-gods. Everyone still has his or her preferences and they choose and act accordingly. There would still be prices of outputs and inputs, production, earning and disbursing of incomes, and so on. In similar fashion, people would still have time preference and therefore, interest rates would exist in the ERE and interest income would be earned by capitalist-entrepreneurs.