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Inflation Issues in Jewish Law
Rabbi Dr. Aaron Levine

Real vs Nominal Interest Rates and the Ribit Interdict

One area of Jewish law profoundly impacted by the phenomenon of inflation is Judaism's prohibition against interest charges (ribit). Helping to focus on one aspect of this impact is the distinction between the real and the nominal interest rate. The real rate of interest is the percentage increase in purchasing power that the borrower pays to the lender for the privilege of borrowing. It indicates the increased ability to purchase goods and services that the lender earns. In contrast, the nominal rate is the percentage by which the money the borrower pays back exceeds the money that he borrowed, making no adjustment for the fall in the purchasing power of this money that results from inflation. Does ribit law merely prohibit the lender from realizing a real return on his loan; or is he interdicted from even earning a nominal return on his loan? Should the former view be taken, legitimacy would be found in the practice of indexing the repayment of a loan to the consumer price index.

Bearing directly on the real-nominal interest rate issue is an analysis of the following Talmudic text in Bava Kamma 97b:

    Raba asked R. Hisda: What would be the law where a man lent his fellow something [on condition of being repaid with] a certain coin and that coin meanwhile was made heavier? He replied: The payment will have to be with the coins that have currency at that time. Said the other: Even if the new coin be of the size of a sieve? -- He replied: Yes... But in such circumstances would not the products have become cheaper? -- R. Ashi therefore said: We have to look into the matter. If it was through the [increased weight of the] coin that prices [of products] dropped, we would have to deduct [from the payment accordingly], but if it was through the market supplies [increasing] that prices dropped, we would have not have to deduct anything. Still would the creditor not derive a benefit from the additional metal? [We must] therefore [act] like R. Papa and R. Huna the son of R. Joshua who gave judgment in an action about coins, according to [the information of] an Arabian market commissioner that the debtor should pay for ten old coins [only] eight new one.

Classic rabbinic interpretation of the above Talmudic text understands the case to refer to the circumstance where subsequent to the loan the government removed from circulation the coin that was lent. In addition to not circulating domestically, the old coin was not used as a medium of exchange elsewhere, or if it was so used the creditor did not enjoy ready access to merchants from the country where it did circulate. Prohibiting the old coin from being used as a medium of exchange, the government replaced it with a new one of greater metallic content. Given the obligation to make payment of a debt with a medium of exchange, the debtor must make payment with the new circulating medium. 1

With the new monetary unit embodying greater purchasing power than the defunct unit, avoidance of ribit law violation apparently calls for the debtor to return fewer coins than he borrowed. A blanket downward adjustment on this basis is, however, rejected by the Talmud. Such an adjustment is not appropriate when the supply of commodities simultaneously increased in the relevant interval. Here, the debtor would be obligated to return the same number of coins he borrowed, notwithstanding the increased purchasing power embodied in the new coins. To be sure, a simultaneous increase in supply of commodities does not automatically rule out favorable treatment for the debtor. Since a coin has intrinsic value, aside from its value as a medium of exchange, downwardly adjusting the payment obligation of the debtor is in order when the increase in metal content of the new coin was at least 20%. Here, melting down the new coin and selling it for its metal content will surely fetch a higher price in the marketplace than the current value of the coin as a medium of exchange. No such advantage would presumably accrue to the coin holder when the increase in the metal content was less than 20%. Here, the cost of converting the coin into bullion as well as the loss of metal involved in the melting down process combine to make the melting down process unprofitable. 2

The above formulation sheds light on the halachic treatment of the converse case involving currency debasement. Suppose the monetary unit A lent B was declared defunct by the government at the time repayment was due and was replaced with a monetary unit containing less metal than the old unit. Suppose further that the new monetary unit commands less real goods and services than the old unit. Does halacha require an upward adjustment in the debtor's payment obligation? Application of the above rules led decisors to call for such an adjustment only if the supply of commodities did not decrease in the interim. Under conditions of stable supply, such an adjustment would not be in order unless the metal content of the monetary unit decreased by 20%. 3

R. Ashi's distinction requires an explanation. With inflation eroding the purchasing power of the monetary unit lent out, why is the debtor's obligation upwardly adjusted only when the exclusive cause of the inflation is an increase in the monetary unit but not when its exclusive cause is a decrease in the supply of commodities?

The distinction, in our view, can be rationalized on the assumption that given the stability of the community's consumption pattern, an increase in the monetary unit, other things equal, will only cause the absolute price level to rise, while leaving the relative price structure intact. In contrast, when the supply of commodities is reduced, other things equal, only the relative price structure will change, while the absolute price level will remain intact. What brings about the change in relative prices in the latter case is the competitive bidding for the commodities in short supply. More money is now spent on the commodities in short supply and less money is spent in other areas. This change in the community's spending pattern will change the relative price structure.

Why the absolute-relative price distinction should prove decisive in determining whether an upward adjustment in the debtor's obligation is in order requires explanation. Examination of the nature of the debtor's obligation to the creditor is here critical. Bearing directly on this issue is the following Talmudic passage in Bava Kamma 94a:

    It was stated: If a man lends his fellow [something] on condition that it should be repaid in a certain coin, and that coin became obsolete. Rab said that the debtor would have to pay the creditor with the coin that had currency at that time, whereas Samuel said that the debtor could say to the creditor, "Go forth and spend it in Mishan." R. Nahman said that the ruling of Samuel might reasonably be applied where the creditor had occasion to go to Mishan, but if he had no occasion [to go there] it would surely not be so.....

Tosafot et alia understand the dispute between Rav and Samuel to refer to the circumstance where A bought merchandise from B on credit or borrowed money from him, with the stipulation that repayment should be made with the medium of exchange. In the absence of this stipulation, all disputants agree that payment is made with the medium of exchange that existed at the time the loan was entered into, notwithstanding that the original monetary unit is now declared defunct and does not even circulate in a foreign country at the time payment is due. 4

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