So your first and second point make sense to me, they together make the nominal interest rate. What I don’t understand is your point about growth. The price of a stock should be determined by the adjusted future returns of the company right? The growth you speak of should be accounted for already in our models of the future returns. So if the price going up that means the models are underestimating future returns right?
The price of the stock is determined by the anticipated inflation-adjusted future returns (including allowance for risk). But increasing price doesn’t mean the models are underestimating future returns, because of opportunity cost. (Which, again, is basically the flipside of growth.)
If the “risk-free interest rate” is 2% in real terms and inflation is 2%, then that means you can (in principle) buy an asset for $1 and be confident that in a year it will be priced at $1.04, which will have the same purchasing power as $1.02 now. There’s no inconsistency in the fact that this is a higher price than you’re paying now, because if you buy the asset now and sell it next year, you’ve lost the use of your money during that time, and whoever you bought it from has gained it. That matters both because we need money for things like food, and because if you have the use of a pile of money you can try to use it for something that adds value to the world and hence grow it.
So your first and second point make sense to me, they together make the nominal interest rate. What I don’t understand is your point about growth. The price of a stock should be determined by the adjusted future returns of the company right? The growth you speak of should be accounted for already in our models of the future returns. So if the price going up that means the models are underestimating future returns right?
No, that’s not quite it.
The price of the stock is determined by the anticipated inflation-adjusted future returns (including allowance for risk). But increasing price doesn’t mean the models are underestimating future returns, because of opportunity cost. (Which, again, is basically the flipside of growth.)
If the “risk-free interest rate” is 2% in real terms and inflation is 2%, then that means you can (in principle) buy an asset for $1 and be confident that in a year it will be priced at $1.04, which will have the same purchasing power as $1.02 now. There’s no inconsistency in the fact that this is a higher price than you’re paying now, because if you buy the asset now and sell it next year, you’ve lost the use of your money during that time, and whoever you bought it from has gained it. That matters both because we need money for things like food, and because if you have the use of a pile of money you can try to use it for something that adds value to the world and hence grow it.
[EDITED to fix a trivial typo.]