The economic basis of interest rates

In a discussion I had with Professor J. J. McCutcheon and Dr W. F. Scott, the authors of the new book on compound interest, An Introduction to the Mathematics of Finance (Heinemann 1986) it was suggested that a chapter describing the theoretical economic background to the determination of interest rates might be of interest to actuarial students. I therefore drafted the substance of this note as such a chapter. In the event it was felt that the subject fitted uneasily with the mainly technical and numerical approach to compound interest appropriate for students at that particular stage of the examinations, and that the more theoretical approach in this note would in any case be of wider actuarial interest. It is therefore presented as this note in the Journal. I am grateful to Professor McCutcheon and Dr Scott for agreeing to this, and to the discussions I had with them while the note was being drafted.