Saving

To increase production, man must form capital. To create it, he must restrict his consumption and transfer his labor for that period to producing immediately-satisfying con­sumers’ goods.

The restriction of con­sumption is called saving, and the transfer of labor and land to the formation of capital goods is called investment.

In a modern economy, large amounts of saved money are usually not hoarded, but rather are used to fund establishment and expansion of business operations.

Saving and capital
It is evident that, for any formation of capital, there must be saving — a restriction of the enjoyment of consumers’ goods in the present — and the investment of the equivalent resources in the production of capital goods. This enjoyment of consumers’ goods — the satisfaction of wants — is called consumption. The saving may result from an increase in the available sup­ply of consumers’ goods. Saving involves the restriction of consumption compared to the amount that could be consumed; it does not always involve an actual reduction in the amount consumed over the previous level of consumption.

Because capital is perishable, it must be renewed, if man wishes to enjoy the fruits of higher production. Saving must be repeated to preserve the structure of capital, over and over.

As Mises put it, "saving and the resulting accumulation of capital goods are at the beginning of every attempt to improve the material conditions of man; they are the foundation of human civilization. Without saving and capital accumulation there could not be any striving toward non-material ends."

Saving and the interest rate
The act of saving is a means through which man can achieve his ultimate goal, which is bettering his situation. Saving implies giving up some benefits at present - this is the price paid for the attainment of the end sought. The value of the price paid is called cost, and costs are equal to the value of the satisfaction which one must forego to attain the end aimed at.

The return on savings must be in excess of the cost of savings. If the costs are too high - if savings can’t better an individual’s life and well being - then saving will not be undertaken.

Consequently, the return on savings must be above the premium for man to agree to save. A positive time preference (i.e., the existence of a premium) precludes the natural emergence of a zero interest rate. Should a zero interest rate be imposed, this will abort all savings and lead to the destruction of the production structure. The premium of having goods now versus having them in the future is getting smaller with the increase in their stock. This, in turn, means that the required return on savings will be lower. An increase in the pool of funding sets the platform for lower interest rates.

Apart from time preferences, the purchasing power of money and business risk are important elements in the formation of interest. However, their importance is assessed in reference to the fundamental factor, which is time preference. For instance, if one dollar buys one apple and the agreed interest rate is 10%, then in one-year’s time the lender of the apple would expect to get back 1.1 apples. The lender of the apple will also be happy to accept $1.1 since this sum will permit him to purchase 1.1 apples.

Let's say the purchasing power of money falls, and the price of an apple increases by 10% to $1.1. Now the lender will not accept $1.1 in one year time, since $1.1 will only buy him one apple. He will require $1.21 to agree to lend since $1.21 will secure the lender 1.1 apples.