A peculiar theory of the rate of interest has been propounded by Professor von Mises and adopted from him by Professor Hayek and also, I think, by Professor Robbins; namely, that changes in the rate of interest can be identified with changes in the relative price levels of consumption-goods and capital-goods.[9] It is not clear how this conclusion is reached. But the argument seems to run as follows. By a somewhat drastic simplification the marginal efficiency of capital is taken as measured by the ratio of the supply price of new consumers goods to the supply price of new producers goods.[10] This is then identified with the rate of interest. The fact is called to notice that a fall in the rate of interest is favourable to investment. Ergo, a fall in the ratio of the price of consumers goods to the price of producers goods is favourable to investment.
By this means a link is established between increased saving by an individual and increased aggregate investment. For it is common ground that increased individual saving will cause a fall in the price of consumers goods, and, quite possibly, a greater fall than in the price of producers goods, hence, according to the above reasoning, it means a reduction in the rate of interest which will stimulate investment. But, of course, a lowering of the marginal efficiency of particular capital assets, and hence a lowering of the schedule of the marginal efficiency of capital in general, has exactly the opposite effect to what the argument assumes. For investment is stimulated either by a raising of the schedule of the marginal efficiency or by a lowering of the rate of interest. As a result of confusing the marginal efficiency of capital with the rate of interest, Professor von Mises and is disciples have got their conclusions exactly the wrong way round.