Concept of Rate of Interest: Right from Adam smith to Keynes, we have had indeed a vast literature explaining the

nature & determination of rate of interest. It is one of the potential weapons in the hands of RBI to control inflation and deflation. In an economy, there can be a number of rates of interest prevailing at a time. Real rate of interest, Money rate of interest, Equilibrium rate of interest, Natural rate of interest. The real rate of interest is one, which equates intended investment and intended saving. The money rate is that which equates the demand for supply of money The equilibrium market rate of interest is one, which presents equilibrium between real Rate of interest and the money rate of interest. That natural rate is one, which equates intended investment & intended saving at the full employment level of income. In this and following chapters, we attempt an examination of mainly four important theories of interest. They are: 1) Classical theory 2) Neo-Classical theory 3) Keynes theory 4) Modern theory in closed economy 5) Modern theory in open economy Classical Theory of Interest: In is proposed by classical writers like Ricardo, Marshall & Pigou, others who subscribe to this are Cassel, Walras, Carve, Taussing and Knight. According to classical economists, interest arises because capital is productive and scarce in relation to demand for it. Equilibrium level of interest is determined where demand for and supply of capital are equating each other. In the diagram, point E identified as equilibrium rate of interest. If rate of interest is rises higher than the equilibrium rate of interest, demand for capital became less than the supply of capital vice versa. Therefore, competition among investors and savers bring back the equilibrium position in the

market. It is possible under the conditions of free play of market forces.

Neo-Classical Theory of Loanable Funds theory of Interest: