The Interest Rate Backfire

When a seventeenth-century parliament decided that borrowing money was simply too expensive, John Locke did not argue with their economics by offering a competing policy; he argued that they were trying to repeal the weather.

In 1691 and 1692, as lawmakers pushed to legally cap interest rates at 4 percent, Locke opposed the bill by insisting that interest is a price fixed by natural market forces. Trying to set it by law, he argued, was as futile as attempting to decree the rental price of houses or ships.

The attempt to legislate the cost of capital creates a predictable distortion. Borrowers desperate to keep trade opportunities alive will still pay the true market rate, driving transactions underground to evade the restriction. Because operating in the shadows carries legal risks and extra friction, those evasion costs are inevitably passed along to the borrower. The legal ceiling, intended to help, ends up driving the actual cost of borrowing higher than it would have been without the law.

Locke warned that forcing rates below their natural value would harass trade and risk a total collapse in commerce. Parliament proved him right in spirit if not in detail, passing a compromise bill that lowered the cap to 5 percent. The enduring lesson is a sharp irony: the political desire to make money cheaper creates the very mechanics that make it more expensive.