We Live in a Free Market Economy - Or Do We?

09/06/2014 12:38 BST | Updated 04/08/2014 10:59 BST

Do you know how the price of money is set? Money is the commodity that makes the world go round - who says what it costs?

Surely the rate is set by the market based on supply and demand - just like any commodity, right? Surely money, the fuel of capitalism, is set in a free market?

Well, the reality is far from the capitalist ideal.

The cost of money is first of all set by central banks. Their goals are rooted in macro economics or, sometimes, in politics. Many may find this reassuring: to hear that central authorities, armed with data and expertise, are determining the cost or the rate of our most everyday commodity. But then for central bank, read a small group of individuals: ultimately the rate-setting decision is the collective view of a committee of individuals. In the UK, it is just nine people - the members of the Monetary Policy Committee (MPC) who meet once a month to decide what we should pay for our money.

On that basis, wouldn't it be better if the rate was set by a much wider collection of people?

This happens - up to a point. On top of the official interest rates set by the central bank, the private sector banks create their own market to set the rate at which money changes hands in the commercial world - and, ultimately, the rate at which you and I save or borrow. This inter-bank market - set by taking a daily sample of around 20 banks - is what produced the now much-maligned Libor rate. A market, yes - but a closed and abused one.

Enter the internet, with its vast reach and break-neck speed of innovation, and we now have a new rate. A rate set entirely by normal people - people lending and borrowing from each other at rates they agree in an online market place. This rate is open to anyone, set in a free market. Rather than a committee of nine individuals who only meet monthly or a panel of 20 banks with questionable objectives, you have thousands and thousands of people forming a consensus on the price of money every minute of every day.

This new rate has come from the online revolution that is peer-to-peer lending. Pioneering savers and borrowers have been freed from having to simply accept the rates handed down to them and are lending and borrowing at rates that suit them. They have been empowered to form their own market. No "teaser" rates, no "zombie" accounts, no bank rate fixing - just a fair market rate.

This liberation has the potential to redefine how people interact with finance: to return more power to the customer and away from the institutions. There is great value on offer as well: unburdened by legacy systems, peer-to-peer lending is proving to be a highly efficient means of matching the supply and demand of money and delivering both sides a better deal.

Central banks will set the official rate, and banks will always set their own rates. But now there is a third rate to consider - a more equitable rate; a rate driven by the crowd that you can influence. The market rate.