In modern times, interest is regarded as the base for the stability of an economy. Nearly all institutions are, in one way or the other, connected to the interest based transactions. Interest is considered as an incentive to save money. Secular economic theory claims that the whole interest mechanism guarantees an efficient allocation of available funds. It keeps the flow of credit stable in the economy.
Today, nearly all financial institutions work on interest based transactions. They all share a common belief that interest based systems provide good incentives to invest and simultaneously earn as per the standard requirements, the result of which ultimately leads towards capital formation and economic growth.
But in real practical world, this is not the case every time. What if a person bears a loss?? Or what if he cannot afford to pay above the principal amount he borrowed?? In both the cases, one becomes a permanent slave of the creditor. He loses his identity and becomes bound to obey what the creditor commands. Today, Pakistan has to pay half of its tax revenues in paying interest alone.
In the earliest times, Aristotle – who is considered as a pioneer figure in secular philosophy – criticized the institution of interest. Thomas Acquinas also stated that the just price of money lent is nothing more than the principal amount lent itself. All Abrahamic religions denounced the institution of interest in clear terms. Even great thinkers like Martin Luther said: “You cannot make money just with money.” Making money with money is referred to earning something in trade by selling what does not exist.
Thomas Aquinas said: “To take usury for money lent is unjust in itself, because this is to sell what does not exist and this evidently leads to inequality which is contrary to justice.”
In the interest based lending, the lender bears no risk in the enterprise of borrower and yet demand and is guaranteed a fixed return. Hence, it leads to an inequitable distribution of income. This can be seen by taking an example of three people. Suppose there are three people who consume all of their income in a given year. One of them starts with $1,000 in savings, a second with $100 and a third with zero. At 10% interest per annum, by the end of the year, the first person has $1,100, the second $110 while the third person has zero in his account. If the same scenario follows in the next year, the first person will have $1,210, the second $121 and the third will have zero. Already, one can see how the distribution between them grows every year, even between the ones who have some savings of their own. This scenario will be made even worse if the richest person will also to be able to add savings. Suppose he adds one thousand at the end of each year. He will have 1,100 at the end of the first year, he adds $1,000 and continues with his 10% interest and he will have $2,310 at the end of the second year, and so on. This scenario ultimately leads to an autonomous inequality in society generated by no one, but suffered by everyone. Note that those in debt, paying interest that grows every year, have not been added to the equation. In their case, as interest continues to grow, more and more of their overall income is consumed by interest, further exacerbating the skewed distribution of income.
On the behavioural side, the one receiving interest indirectly tags money as risk-free and work-free. This leads to a lifestyle mainly based on consumption. But more importantly, it leads to a very irresponsible attitude towards one own self and the society.
On the social equality front, the one paying interest becomes a slave of those who lent him money since the burden gets bigger over time. This leads dependency and leaves self-empowerment as mere fantasy and ultimately leads towards loss of self-identity, self-honour and destruction of humanity.
John Maynard Keynes, a well-known economist of the west, who unveiled the mysteries behind the great economic crisis on earth, also argued that the best way to revive the economy is to increase the money supply so that the rate of interest falls. A fall in the rate of interest would lead to higher investment, employment and output. In fact, Keynes held that ultimately an ideal economy is one wherein interest does not exist.
It is now that Economists like Milton Friedman, Kindle Berger and H.C. Simon hold fixed interest rates to be responsible for instability. Friedman contends that changes in rate of interest bring about either inflation or deflation and both are harmful to the society. He therefore argues “Our final rule for the optimum quantity of money is that it will be attained by a rate of price deflation that makes the nominal rate of interest equal to zero”. This proposition is known as Friedman’s Rule, and it is “one of the most celebrated propositions in modern monetary theory”.