Collecting rent for monies lent is called usury. The two Abrahamic faiths, Judaism and Islam, do not agree on this. The Hebrews, the circumcised descendants of The Covenant, like to lend money on interest. The other circumcised followers of the same covenant, the Muslims do not like to lend on interest. So, they innovated a new form of finance known as Islamic finance where they bury the interest in a higher “future” sale price. The uncircumcised European acolytes of Jesus the Jew, who decried the money changers outside the Temple in Jerusalem for despoiling the altar of YHWH and was crucified for it, are pharisaical about interest. The gentiles are, at once, both Jewish and Muslim when viewed through the lens of usury.
Economic science defines interest as the time value of money, whether that “money” be sheep and goats of the era of barter (the theory of supply and demand where the equilibrium price is still real) or printed on ever more sophisticated forms of papyrus, since perhaps the idea of printing money arose in someone’s head, to locate all value in the real and none in the convenience to transact the real (the definition of fiat money because it facilitates barter through a relatively abundant commodity, paper, and, therefore, a relatively valueless proxy), long after the Chinese invented paper in the 2nd century and paper money, perhaps even printed paper money, in the 10th century and after the first bibles were printed in Gutenberg’s emerging Protestant Germany in the 15th century, all common era.
The time value of money is technically the opportunity cost of money for economists: the best place to use it for the most return for permitting it to be used ― what we must forego to gain what we need, and sometimes want. A money lender ― Hindu, Jewish, Christian or Islamic ― whatever the mode of finance, must always mix in a basket the various opportunities of return on his lending, to minimize his loss and maximize his gains. This, as every financier everywhere knows, is called a portfolio. The central banks of the world are no exception to this.
The Federal Reserve System (Fed) sanctions the printing of paper money whenever it wants to buy or sell the collateral on the state of the economy known as government bonds. Bonds, because they are a proxy for economic activity, are an asset. Paper money, because the government is obligated to honor it for the value it represents, is a liability on the balance sheet of the Federal Reserve. The Fed issues paper when it buys bonds and retracts the paper it already issued when it sells bonds. And only it can do so.
The time value of the paper money the Fed has in circulation at any given time is, therefore, dependent upon the maturity mix of the government bonds it buys and sells to issue money. The Federal Reserve, contrary to the popular story that it can only control the short term interest rate, is wrong. At will, it can control the interest rate in any time horizon depending on the mix of bond maturities it buys or sells, bonds being guarantors of a fixed income for its holders for holding them, thus a liability for the government (Treasury) that issues them. Government assets and liabilities are thus a matter of double-entry bookkeeping across government institutions or functions: an asset here is a liability there and vice versa. What matters is always what is real.
The rent to hold a bond between the point of issuance and the point of maturity is known as the term structure of interest rates or the yield curve. This is the time period within which the financial institutions, which buy and sell bonds from and to the Federal Reserve, buy and sell them in the markets to reflect their confidence in the collateral: the real economy, varying the shape of the yield curve over time.
The relationship between interest rates in the short run and the long run can, therefore, be best illustrated by producing a yield curve of the weighted index of the Fed’s bond portfolio, not of the spread between a specific short term instrument (3-month Treasury note) and a specific long term instrument (10-year Treasury note), also neologized as a composite yield curve of the various Treasury bills in the portfolio of the Federal Reserve. Even without a composite yield curve, the conventional yield curve is the relationship between short and long rates. The yield curve, conventional or composite, exists because of how lenders, commercial bankers and investment bankers, earn their income. They borrow short at lower rates and lend long (commercial loans, corporate bonds portfolios, stocks) at higher rates for real investment toward the “cycles” of production in agriculture and industry.
All spreads matter if the Fed is to have flexibility in the conduct of monetary policy. Any pretense by economists and economic and financial institutions that they do not understand the usury of the short and long is, therefore, just that. Pretense. Both bonds and paper (or money by government decree or fiat) are, in the much hyped jargon of Alan Greenspan’s masters of the universe on Wall Street, both derivatives of the zeroth order in the language of mathematics, because they are derived from the real things people consume everyday and make for consumption (demand and supply). More derivatives (aka financial engineering or the hyped genius of innovating a pyramid money scam of combining derivatives and their derivatives), therefore, implies more money over time chasing the same goods. The Fed always has to pay either now or later. To whom and when it pays how much is the Russian roulette for the people and the well-structured normative political-economic game between the Fed, the Treasury and the financiers on Wall Street. The Clinton economic ideology, inherited by Bush and Obama, has only put off inflation by claiming to end the business cycle with money (low interest rates aka liquidity freedoms, not liquidity traps) through the crises of economies elsewhere and now at home, because slowing down the economy depresses inflation.
This is the way the world works.