Dollars of interest payments circulate just like any initial, transitional, or final payments. There’s no mystery here.
Contractual interest is what the obligor-lender charges the obligee-borrower for temporary use of the obligor’s money. The contractual interest rate or coupon rate is determined in negotiation between the parties by considering the supply and demand for funds, the estimated opportunity cost for the obligor, and the probable prospects of repayment of principal vs. the probability of default of the obligee, and the associated inflation risk, foreign currency risk, and political risk..
Contractual interest is a rental charge as payment for the privilege of usage, just as rent is a payment for the benefit of shelter services.
Contractual interest is charged in conjunction with one of five classifications of demand for money.
- To support an initial or transitional outlay for the production of capital goods (including outlays for repair and maintenance of existing capital goods): i.e. to support surplus supply of capital goods
- To support an initial or transitional outlay in production of consumer goods: i.e. to support basic supply of consumer goods
- To support the financing of an expenditure for capital goods: i.e. to support surplus demand for capital goods
- To support the financing of a purchase of consumer goods: i.e. to support basic demand for consumer goods
- To finance gambling or an exchange of title to ownership of static wealth within the secondary market of the redistributive function: a redistributive transaction
Contractual interest may be paid directly to an individual lender to constitute entirely an initial operative payment, or it may be paid first to a banker-intermediary, who will then apportion it as a.) an initial payment as wages and salaries to its employees, and as dividends and retained earnings to its owners b.) a transitional payment to the bank’s suppliers, or c.) a redistributive payment from the borrower Jones to the bank’s depositors and bond holders Smiths.
To review, an expansion of the economy requires additional credit (borrowed) money for expanded initial, transitional, and final payments in the operative circuits. This additional credit money bears an interest charge. The resulting interest payments circulate within the channels of circulation just as dollars of wage payments, rent payments, materials-supplies payments, etc. Contractual interest is a rental charge to Jones as payment to Smith for the privilege of using Smith’s money, just as rent is a payment for use of shelter services. There’s no mystery here. Payments circulate within the basic and surplus channels of circulation.