There’s so much to say about interest rates. Many people think about them in the context of whether they should refinance or in terms of their impact on borrowing. But interest rates also matter for production beyond impacting loans for new productive projects. Interest rates aren’t just a topic for debtors.
Interest rates impact all production that takes time. That’s the same as saying that interest rates affect all production – but the impact is easier to see for products that require more time to produce.
There’s this nice model called ‘Portfolio Theory’. Taken literally, it says that everything you own can be evaluated in terms of its liquidity, the time until it will be sold, its expected returns, and the volatility and correlation of those returns. Once you start to look at the world with this model, then it’s much easier to interpret. Buying a car? That’s usually a bad investment. It’s better to tie up a smaller amount of money into that depreciating asset rather than to let a larger sum of money experience dependably negative returns. Of course, this assumes that there are alternative uses for your money and alternative places to invest your resources – hopefully in assets with growing rather than decaying value. People often recommend purchasing used cars rather than new cars. Both new and used cars are bad investments and you can choose to invest a lot or a little.
Producers make a similar calculation. All kinds of things motivate them: love, tradition, excellence… But everyone responds to incentives. Consider vintners. They might be a farmer of grapes and a manufacturer and seller of wine. They might like to talk about nostalgia, forward notes, a peppery nose, and other finer things. But even they respond to prices and opportunity cost.
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