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The author at PRESTOPUNDIT in a related article titled BRYAN CAPLAN argues that "time preference" is a writes:
The author at Mises Economics Blog in a related article titled Time Preference Confirmed writes:
The author at Mises Economics Blog in a related article titled Hey Rocky, Watch Me Prove Positive Interest Rates Without Time Preference! writes:
COMMENTS (28 to date)
Mike Linksvayer writes:
Interesting article, has encouraged me to go back and digest http://www.gmu.edu/departments/economics/bcaplan/whyaust.htm soon. Isn't it a stretch in your 'food price doubles next year' example to say there's a negative interest rate because you can get half a pound of food next year for one pound now? If you translate those quantities of food delivered now and 1 year from now into money you get a zero percent interest rate: if you know the price of food doubles next year, you're trading $1 worth of food today for $1 worth of food next year. Posted March 10, 2005 9:10 PM
Maestro writes:
Good points. Related to the non-spoilage factor is my point. If you could receive a new car now or in a year, you don't need time preference to choose to take it now. You take it now so that you will enjoy it for a year longer than you would with the second option. However, this isn't necessarily so if the wear and tear factor is great enough. Posted March 10, 2005 9:15 PM
Steve Miller writes:
Let me think this through, using the tired beer example. Diminishing marginal utility means that the first beer is enjoyable, the second possibly a little more, but eventually subsequent beers have diminishing marginal utility. This particular example sort of assumes that we're talking about one time period of some fixed length. I suppose what you're saying is that this can be extended to a lifetime, also of a fixed length. Let's see if that's true of the beer example. Beers consumed early in life have a higher marginal utility than beers consumed later in life? That doesn't make nearly as much sense as saying that beers consumed early in the evening have a higher marginal utility than beers consumed later in the evening. The buffet meal story in the link you gave is very similar. But beer is weird like that, it goes through your system (my dad says you never buy beer, you only rent it). So maybe cars? Do cars purchased earlier in life have a higher marginal utility than cars purchased later in life? Or is the diminishing marginal utility about how many cars I have at once? The first car is very useful, it makes it possible to go all kinds of places. The second one is slightly less useful at the margin, but still useful (it can serve as a backup to the first car when it breaks down, etc.). The third has a lower marg. utility, and so on. But what the heck does that have to do with borrowing money to have one car now? It still seems that the reason I would borrow money to buy a car is because I prefer a car now to a car in the future. That's time preference. It seems like I'm willing to pay interest because of a time preference, not because subsequent cars purchased will have lower marginal utility. It doesn't really seem like the concept of diminishing marginal utility has much to do with time at all. If you're saying that the marginal utility of a car now is higher than the marginal utility of a car in the future, then we're saying the same thing, and it's just a matter of semantics... isn't it? Posted March 10, 2005 9:42 PM
Steve Miller writes:
Maestro wrote: "If you could receive a new car now or in a year, you don't need time preference to choose to take it now. You take it now so that you will enjoy it for a year longer than you would with the second option." Taking a car "now so that you will enjoy it for a year longer" sounds exactly like time preference to me. Posted March 10, 2005 9:49 PM
Maestro writes:
'Taking a car "now so that you will enjoy it for a year longer" sounds exactly like time preference to me.' Posted March 10, 2005 11:08 PM
Don Lloyd writes:
If this seems crazy to you, suppose food were the only commodity, and you expect a famine next year. Wouldn't you happily trade 2 pounds of current food in exchange for a promissory note good for 1 pound of food next year? Actually, no. If you expect a famine, your promissary note may be worth no more than the calories it provides when you eat it. Regards, Don Posted March 10, 2005 11:56 PM
Steve Miller writes:
I'd say they're both basically the same thing. With the car, because it stays useful longer, you get to use it today and all the days in between. For a doughnut the time period is measured in hours at most. But you'd still rather use it sooner than later. If you desired a doughnut and didn't have the 50 cents to pay for it, you might consider my offer to give you a doughnut today in exchange for 51 cents tomorrow. Posted March 10, 2005 11:56 PM
Michael Messina writes:
I think the banana example is flawed. If you just cared about marginal utility, you would never eat them because their utility would increase the hungrier you got. Also, saying that we disvalue hunger equally both days is sort of like asking "Would you like to live today or tomorrow?". You can't live tomorrow if you die today. Also, the negative 50% interest rate on food example seems flawed, because there isn't a negative interest rate in dollar terms. The famine example gets back to the live today/tomorrow problem and there isn't any money basis given. There are two sides to a lending transaction, borrower and lender. It seems obvious that the borrower has a time preference for reasons Steve Miller gives above, while the lender presumably has excess funds with a corresponding diminished marginal utility. However, I suggest that the lender actually has a time preference as well. Time preference is the idea that present consumption is valued over future consumption; however, this is a reversible concept: there is an increased amount of future consumption that is valued the same as present consumption. If you are offered a promise of excess value in the future over the value of current consumption, then, rationally, you would take it. This makes the statement "time preference explains positive interest" a tautology. A time preference means a positive interest rate and vice versa. Bringing inflation into the mix doesn't affect this since once the funds are lent there is no longer any time preference at work. The positive interest rate in question is the one set at the time the money is lent. Posted March 11, 2005 3:51 AM
Greg Ransom writes:
What Caplan calls "the stock answer of Austrian economists" is _not_ Friedrich Hayek's answer, so it's deeply misleading to suggest that Austrians have only one answer to this question. Hayek shows that time preference and productivity are inter-related and combine to produce positive "interest" returns on _capital_. Bringing in positive returns on _money_ adds a whole different and new level of complexity to the matter. Of course, economists have punted on all of this -- they don't have a theory/logic of disaggregated interest/capital. In other words, they haven't produced a logic of the marginal valuation of production goods through time, as they have with the valuation of consumption goods without production. And what I mean by "punted" is simply this -- they haven't tried, they haven't looked into why it might not be possible to do so, and they haven't comtemplated the significance of their failure to do so. And you are right if you're thinking that this is about as embarrassing as it gets in a scientific discipline. For those interested in the topic of "Austrian" interest / capital theory, let me recommend _The Austrian Subjectivist Theory of Interest_ by Ingo Pellengahr. Peter Lang: 1996. Posted March 11, 2005 4:05 AM
Bob Knaus writes:
I think Mike and some others misunderstand Bryan's example. In barter markets, of course the interest rate is frequently negative, because the unit of exchange is FOOD, not money. If you move to a market where the unit of exchange for delivery of food is money, then of course $1 of food today = $1 of food next year discounted to present value at the prevailing interest rate. But then it's not a barter market any more, is it? This is why, despite what you read in some sleazy promotional materials, that it is impossible to be certain of making money in the commodity futures markets on seasonal prices swings. Posted March 11, 2005 6:47 AM
Luca writes:
In the barter example it looks like that the factor that makes the interest rate negative is not the barter mechanism but the assumption that food is perishable. If you store some salted cod today, you can barter it for twice the stuff a year from now, and therefore the interest rate is 100% (minus storage costs) instead of -50%. Regarding the economic growth example: isn't a difference in marginal utility just influencing my time preference, rather than being a completely different interest rate framework? Posted March 11, 2005 9:12 AM
Randy writes:
This reminds me of a Finance class I took years age. I was asked to explain the time value of money. My answer was something about the money amount changing over time because time has value. He told me I was wrong - what he wanted was the definiton - but I always thought I was right. I think Bryan is right, but I still think I'm right. Time has value. Products have value. What interest rates determine is the relationship between the value of the time and the value of the product. Or I might just be wrong... Posted March 11, 2005 9:36 AM
Joseph R. Stromberg writes:
[I suppose we can expect something like this in the near future?] Forthcoming by B***n K****n: "Why Wheels Do Not Require the Concept of Roundness." Summary: Austrians are wrong to attribute roundness to wheels. All that is needed is a bounded constantly receding surface set upon a larger constantly flat surface. Throw in Bayesian probability (or some such thing), and we see that Austrians have been mistaken about roundness for almost 200 years. Roundness is just a wheel in the head. Joseph R. Stromberg, Posted March 11, 2005 11:54 AM
Mike Linksvayer writes:
Bob Knaus: The example stipulates that the price of food will double next year. However, disregarding that and taking food as the unit of exchange, it sounds to me like the next year is deflationary and you have a zero real interest rate. Bryan Caplan: Upon re-reading, I missed the argument that diminishing marginal utility explains the existence of interest, i.e. the argument does not exist above. All you've explained above with diminishing marginal utility is why people might want to delay consumption. That seems completely orthogonal to time preference, and a non-explanation for interest. Finally (me not knowing anything about theories of interest) isn't it obvious that interest is a price, determined by a meeting of supply and demand, and is never negative for the same reasons blowout sales might have really low prices, but never zero nor negative prices? Posted March 11, 2005 12:08 PM
Patrick R. Sullivan writes:
Nominal interest rates aren't always positive. They were negative in Japan a few years ago. The reason being http://research.stlouisfed.org/publications/mt/19990101/cover.pdf Posted March 11, 2005 12:11 PM
Pete Canning writes:
"Gold has (almost?) always been more expensive than silver, but we don't need to postulate "gold preference" to explain this pattern. The greater scarcity of gold is all the explanation we need." Actually, if no one had a preference for gold over silver gold would be cheaper than silver. Even though there is less of it. Posted March 11, 2005 2:15 PM
jsale515 writes:
Bryan Caplan completely misconceives the relationship between the law of marginal utility, time preference, the intertemporal allocation of resources and the interest rate. Time preference is a "category" of human action, meaning that any act undertaken brings the actor's goal closer in time and demonstrates a preference for satisfaction sooner rather than later. Another way of putting it is that no one has an infinite time horizon. Everyone without exception has a finite "period of provision," beyond which the achievement of any goal is valueless to the actor. The term "positive time preference" is therefore redundant and the concept of "negative time preference" is logically contradictory. Zero time preference would occur only in a world in which everyone was completely satisfied at every moment of time and need not ever act--think of a world in which consumer goods rained like manna from the heavens at every spot on earth and each individual could instantaneously clone himself an infinite number of times so that his capacity for enjoying this superabundance was also unlimited and you come close to imagining a zero time preference world. Posted March 11, 2005 3:18 PM
Lancelot Finn writes:
Well, I'm with you. Time preference always seemed fishy to me, because it is arbitrary. It's one of those things economics students have trouble with. "So you're saying people are irrational, they want everything now and don't think about the future enough?" "No, they're rational. The future is worth less than the present to them." Of course, time preference is a convenient assumption for lots of economic models. But when you just assume time preference, you induce an uncritical attitude towards it. I suspect there's a lot to be learn from dropping the assumption of time preference, substituting, let's say, an assumption that consumption today and consumption tomorrow are valued equally, and then trying to explain the phenomenon of time preference with reference to the life-cycle, uncertainty, general economic growth, and personal accumulation of human capital. This could lead to studies of why the rate of time preference seems to differ across countries, and what policies or socio-cultural variables influence the rate of time preference, and whether a lower rate of time preference is socially beneficial. In short, I think you're dead on, and I hope your insights conquer and transform the discipline. Posted March 11, 2005 3:59 PM
Lawrance George Lux writes:
Bryan, Posted March 11, 2005 8:26 PM
El Presidente writes:
Greg Ransom: "...economists have punted on all of this..." That's the truth. The marginal utility of an item is distorted by the scarcity of time. Sooner or later you will die (nothing personal). The myth of onward and upward is meaningless to someone who is seized with their own mortality. Pardon the jingoism but fear and consumption is the order of the day. Hayek pointed out that monopolies (or simply anti-competitive producers) are the catalyst for unrest and socialism in Road to Serfdom . When a person realizes they are woefully outmatched by the provider of their sustenance they grow uneasy. The time preference is to consume everything one can before death. Remove immediacy from need and there is no time preference (corporations are the only economic participants that have this advantage because they are, in theory, immortal). Then marginal utility plays a role when one realizes that they cannot consume everything. So we scheme about how we can consume in a way that provides maximal pleasure and thus there are trade-offs. You cannot deal with the time preference factor that generates willingness to pay interest and the marginal utility factor that causes us to decide which items are most worth that interest as mutually exclusive. Synthesis is lame, right? Consider this. An elderly person decides that a life of frugality as a good "worker bee" should finally be rewarded. They purchase a home at an outrageous interest rate they cannot afford. They could care less. They are about to die. They never intend to repay the interest. So, instead of making their payment, they go to Vegas and buy a sports car. Their acceptance of their own mortality has freed them from both marginal utility and time preference considerations to a significant degree. Posted March 11, 2005 8:43 PM
Phil Birnbaum writes:
There are some goods that do not appreciably depreciate and decay – say, land, or a nice set of silverware. Now, suppose I own some land. Clearly, I want to use the land, because otherwise, I would sell it and buy something else. Therefore, it’s going to take a payment to me – rent – to for me to let you use my land for a year. How much rent? Depends, but suppose I expect to live 40 years. Even with no time preference, you’d expect me to want at least 1/40 of the cost of the land to give it up for a year. Now, suppose interest rates were zero. I’d just borrow money at 0%, buy the land, lend it out at 1/40 (or 2.5%), and live off the income. The demand for money to do this would push interest rates up to at least 2.5%. This would happen even if there was generally a *negative* time preference for other goods. It seems to me that it’s not only the preference for goods now instead of later, but the preference to have those same goods *both* now AND later that is the basis for a positive interest rate. Phil Posted March 11, 2005 9:34 PM
Tom writes:
But before we try to explain why interest rates are always positive, we should make sure that they are always positive. In barter markets, interest rates are frequently negative. Suppose we knew the price of food would double next year. Then a pound of food now trades for half a pound of food one year from now. Translation: a negative 50% interest rate! If this seems crazy to you, suppose food were the only commodity, and you expect a famine next year. Wouldn't you happily trade 2 pounds of current food in exchange for a promissory note good for 1 pound of food next year? The first example is ridiculous. Barter markets involve complex trades. They're not just about food-for-food. They're about food-for-clothing, etc. Moreover, how do buyers "know" that the price of food will double next year? And if buyers do somehow "know" that it will double, they'll bid up the price of food this year, in order to store it for use next year (not all food being perishable). Result (ignoring time preference): the price of food (in terms of other goods) will double this year, ceteris paribus. Interest rate: zero. Similarly, if a famine is expected next year, the price of food will rise this year. And so on, as in the preceding paragraph. Imagine you are going to inherit $1,000,000 next year. According to the law of diminishing marginal utility, you would want to increase your consumption now when the marginal utility is high, and pay for it by cutting back your consumption in the future when the marginal utility is low. No time preference story need apply. Why should my marginal utility be higher this year than next year (unless I have a time preference for consumption this year)? This year is this year and next year is next year. I want more consumption this year -- and next year -- because additional consumption of something always has positive marginal utility. I'm willing to subdue my taste for more consumption this year only if I can be assured of even more consumption next year. That's called time preference, and that's why I require a positive rate of interest as the price of forgoing some consumption this year in favor of more consumption next year. Try again. Posted March 11, 2005 10:42 PM
Bill Woolsey writes:
The "Myth of Time Preference" is a poor choice of headline. There was a paper making a similar point to Caplan's many years ago. Perhaps someone else can remember the author, title, ect. That paper pointed out that "time preference" has a different meaning in neo-classical and in misian ecnomics. In neo-classical economics, it means that there is a particular bias towards present or future consumption. A simple way to look at it is that if one had constant income and no interest, then one would consume one's income each period if one had zero or no time preference. Positive time preference (or just "time preference") means that in such a situation one would consume more now and less in the future. Consumption over time would be allocated so that it gradually decreases. One's preferences are such that future consumption is consistently discounted. Negative time preference would be the opposite. Given constant income and no interest, consumption would gradually increase. Negative time preference wouldn't mean that people never consume, however. That is because of diminishing marginal utility. You just have gradually increasing consumption. The discounted (or premiumed) marginal utility of consumption is equated. The discount or premium shows this consistent bias in one's preferences. Figuring out what time preference means in Austrian economics is more difficult. To the degree it is a category of human action as mentioned by sale (quoting Mises,) then it doesn't The article I mentioned above claimed that time preference in Austrian economics really means that people care when they consume. If no one cared when they consumed, there would be no phenomenon of interest. Of course, that doesn't require that the interest rate be positive at all times. I think such a claim isn't controversial, but that most economists wouldn't consider this very important. Then again, most economists use the term "time preference" in a way that is aimed and understanding what the level of the interest rate would be. People's preferences regarding future and present consumption would seem to be a factor. That factor without which the phenomenon of interest couldn't exist isn't of much interest to most economists. And, of course, the notion that the interest rate must always be positive is most likely just wrong. It just requires that at some point, more round about methods of production become less productive. Or, in neo-classical terms, the marginal value product of capital become negative. In my opinion, this is possible. And it is even likely to happen from time to time for short periods. One final note--Caplan's argument about money interest suggests that the interest rate can be no more negative than the storage cost of money. And what happens if there is a pure credit money? Who will issue money at zero interest if earning assets all provide negative returns? Posted March 13, 2005 9:34 AM
jaimito writes:
In times of war and uncertainty, people pays for somebody storing value for them. Id est, negative interest rate. Positive interest rate implies a mood of optimism that believes things will be better in the future. That productive enterprises will prosper, that no catastrophy is in view, peace and stability is here for ever. Pessimists, as El Presidente pointed out, know that in the end optimists will be shown wrong and therfore will pay for security. It may be a question of temperament. Posted March 14, 2005 2:41 AM
Joshua Allen writes:
The economist arguments on both sides seem to rely on assumptions of scarcity which are simply not credible: A) People are motivated to consume their whole pile (or as much as possible) before dying. This is clearly false. The fact that the earth supports 5 billion more people today than 2000 years ago proves that, on average, we leave behind more than we started with. When the only scarce resource is time, that would seem to change the economists equation of self interest. One can gorge only so much. Posted March 15, 2005 4:40 PM
Barkley Rosser writes:
I agree with those who say the food barter Posted March 18, 2005 3:51 PM
Noumenon writes:
You have an extremely impressive set of commenters at this site. Posted March 19, 2005 6:28 AM
Barkley Rosser writes:
Another reason for positive subjective time Posted March 19, 2005 11:02 AM
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