Obviously then, the demand for capital at any particular moment depends not so much on the productivity that the existing structure of real capital would have if completed—the long term schedule of the productivity of investment as on the proportion between that part of it which has already been completed and that part which has yet to be added to complete it. Only for a very small fraction of the total investments the marginal investments which represent the beginning of new chains of invest-ment will the demand for funds promptly react to a change in the rate at which capital can be borrowed. For the rest, the demand for capital will be highly inelastic with respect to changes in the rate of interest.
The consequences of this can readily be shown by a schematic example. Assume that past investments have been guided by the ex¬pectation that a rate of interest of four per cent would continue to rule for some time, but that in order to complete the investments which have been undertaken in this expectation a greater supply of loan able funds would be required than is actually forthcoming. Assume further that, if investments in the recent past had been guided by the expectation of a five per cent rate of interest, the amount of further loans required to continue these investment processes would just exhaust the current supply. This does not mean that once investments have been undertaken in the expectation of a rate of four per cent, a rise of the interest rate to five percent that is, to the figure which, if correctly foreseen, would have represented an equilibrium rate will now be sufficient to reduce demand for loans to the level of the supply. If a considerable part of the equipment to be used has already been produced, many investments, which it would never have been profitable to start if a rate of interest of five per cent had been foreseen, will be well worth while continuing, even at a rate much higher than five per cent. The loss will fall entirely on those entrepreneurs who in the past, in the expectation of the lower rate of interest, have already erected new plant, etc. But the concessions in price, below their actual cost of production, which they will be compelled to make, will enable the other entrepreneurs, whom they supply with equipment, to go on with the in¬stallation of new machinery, which would not have been possible if developments had been foreseen correctly from the outset. The construction of a large hydro-electric plant that would have been profitable if the rate of interest had remained at four per cent will prove un¬profitable if the rate of interest rises. But, once it has been constructed and charges for electric power adjusted to get maximum profit over cur¬rent expenditure, it will give rise to a further demand for capital for the installation of elec¬tric motors, etc., which will not be sensibly reduced even by a rate of interest much higher than five per cent.
How far the rate of interest will have to rise to bring the demand for loans down to the avail¬able supplies will depend, as we have seen, on the proportion between that part of the com¬plete investment processes which had been carried out before the unexpected rise in the rate of interest occurred, and that part of this total expenditure which has yet to be incurred. If, in a particular instance, interest at four per cent on the capital already invested and amor¬tization of that capital would have represented 30 per cent of the expected price of the final commodity in the production of which it was to be used, then interest charges involved in utilizing the existing plant and its products would have to rise so as to absorb the whole of this 30 per cent of the final price, before the demand for capital for this purpose would be effectively curtailed. If, of the remaining 70 per cent of the expected total cost of the final product, 15 per cent was allowed for further interest at four per cent, interest rates would have to rise to approximately 12 per cent before the profitability of the investments completing the process already begun would be reduced to zero.
Against this whole argumentation it might be objected that it completely ignores the effect of the rise in interest rates on current replacement of the capital in the "earlier stages" which has partly or entirely lost its value. It is certainly true that these items of equipment will not be replaced. But the implication that this will in any way relieve the demand for funds for investment is certainly erroneous. In so far as those items in the normal course of affairs would already need replacement, these replacements would have been financed out of amortization currently earned. They would not have constituted a demand on the funds available for investments. But if and this is more likely they have not yet become ripe for replacement, the amortization earned would temporarily be available for investment elsewhere. The fact that no amortization or only a reduced quota will be earned will then mean a reduction of the supply of investible funds, that is, it will represent a factor which tends to raise rather than lower the rate of interest.
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