New Results in Capital Theory and Implications for the Theory of Inflation

Abstract

The main policy to fight modern inflations is to raise interest rates. This lowers the pressure of demand and thus curbs the rise of prices. But interest is an element in cost of production and higher interest rates render the financing of investment more difficult. If the rise of interest costs is persistent, it adds to costs in the long run and becomes a component of long-run prices, so that it is not obvious what will prevail. In this paper, we focus on the long-run aspect using the classical theory of long-run prices (Sraffa, 1960). Under this approach if the interest rate results from monetary policy, this will determine the rate of profit and also the wage rate. In the context of the Monetary Theory of Distribution, raising interest rates at first adds to inflation by imposing additional costs on producers. We call this the Tooke effect. However, the sudden rise of the rate of interest reduces effective demand, exerting a pressure on prices, which, according to all experience, ultimately prevails and inflation is reduced.

Date of presentation: 08-21-2023

Date of approval: 09-10-2023

JEL classification: B51 ; E43 ; E52