WEBVTT NOTE The Pure Time Preference Theory of Interest and Its Enemies 1 00:00:00.000 --> 00:00:19.000 I just want to focus on one thing, one main issue from this paper. As you can imagine from the title, it's rather expansive, and this is the issue that was posed by Boehm-Bawerk. Murray writes in Positive Theory. 2 00:00:19.000 --> 00:00:27.000 The difficulty is, and indeed I think it is at once the greatest and most stimulating difficulty of the whole problem of interest. 3 00:00:27.000 --> 00:00:48.000 The difficulty is to explain in what manner and by the employment of what intermediary processes, those heterogeneous component elements, they include objective technical factors and highly subjective psychological motives, combine and cooperate to produce that end result, which we know as the homogeneous phenomena of interest. 4 00:00:48.000 --> 00:01:12.000 That truly is a key question in interest rate theory and what I will argue here is that the pure time preference theorists were the ones, this is the line of thought in interest theory that is consistent with Menger's causal realist framework of economics. 5 00:01:12.000 --> 00:01:18.000 And that's what I hope to demonstrate for you here quickly today. 6 00:01:18.000 --> 00:01:28.000 Menger's conception, if I might state it briefly, from the Marginalist Revolution as opposed to Jevons and Varra, 7 00:01:28.000 --> 00:01:41.000 was that in human action the human mind integrates all of the different factors that are relevant for action. 8 00:01:41.000 --> 00:01:56.000 It's the human mind that is the organizing phenomena of human action, and therefore it's the judgment of the human mind that is the determining factor in every element of human action. 9 00:01:56.000 --> 00:02:05.000 There are, of course, objective factors in human action, but their influence to the actor depends upon the judgment of the actor's mind. 10 00:02:05.000 --> 00:02:33.000 Now, if we look at this, if we look at a sketch of the pure time preference theory of interest with respect to this conception, it might look something like this, and at the top I just have a kind of Mengerian system of cause and causal chain, as we move from preferences that people have in their minds, to demands that people have in their minds. 11 00:02:33.000 --> 00:02:41.000 to demand and supply in markets for goods, which then determine the prices of goods. 12 00:02:41.000 --> 00:02:47.000 So we have this classic Austrian argument that it's preferences or subjective value that determine prices. 13 00:02:47.000 --> 00:02:55.000 And as we know, the causal chain continues from the prices of goods to the marginal revenue product to the factors of production. 14 00:02:55.000 --> 00:03:06.000 I point this out, again, in interest theory, because there are a lot of interest theories that claim that productivity has an independent effect on interest. 15 00:03:06.000 --> 00:03:14.000 But in the McGarrion conception, this is not correct. It has no, in fact, direct causal effect on interest at all. 16 00:03:14.000 --> 00:03:20.000 The productivity factors, both physical and value productivity, as Boehm-Bawerk put it, 17 00:03:20.000 --> 00:03:26.560 enter into the prices of the factors of production and then through rental prices of these factors 18 00:03:26.560 --> 00:03:30.120 of production into the capital value of assets. 19 00:03:30.120 --> 00:03:35.200 And you'll notice that the capital value of assets is determined by the sum of the rental 20 00:03:35.200 --> 00:03:38.040 prices discounted by the rate of interest. 21 00:03:38.040 --> 00:03:42.160 This was a key point made by Frank Feder that we'll talk about in a minute. 22 00:03:42.160 --> 00:03:47.640 So the argument then is that time preferences have the same causal link to the interest 23 00:03:47.640 --> 00:03:53.640 and the interest rate as a price, as preferences generally have through demand and supply to the prices of goods. 24 00:03:53.640 --> 00:03:57.640 So that is a quick schematic of this. 25 00:03:57.640 --> 00:04:03.640 Now, I want to end, I'll elaborate in a moment on some of these points, 26 00:04:03.640 --> 00:04:13.640 but I want to say that this theory was actually brought forth by the great American economist, 27 00:04:13.640 --> 00:04:20.640 and economist, Frank Fetter, in a book that he published, Principles of Economics in 1904, 28 00:04:20.640 --> 00:04:25.660 and you might note the date, 1904 is eight years before the publication of Theory of 29 00:04:25.660 --> 00:04:34.120 Money and Credit, where Mises integrates money and the theory of money into Menger's system. 30 00:04:34.120 --> 00:04:37.800 This is a very early work and it's a very brilliant work, and one that I would argue 31 00:04:37.800 --> 00:04:44.280 who still stands up against all of the criticisms against this theory. 32 00:04:44.280 --> 00:04:53.600 Here is Joseph Dorfman, the great historian of thought of American economists on Fedder, 33 00:04:53.600 --> 00:05:02.000 where you can see his statement here, his assessment of Fedder's argument of this theory 34 00:05:02.000 --> 00:05:03.000 of interest. 35 00:05:03.000 --> 00:05:15.000 Since the impulse to seek immediate gratification was rooted in men's nature, in Feder's theory, the gratification of wants at a future date was not as important as present gratification. 36 00:05:15.000 --> 00:05:24.000 Thus he found time value pervading the entire economic structure and the capitalization of psychic income, a basic process of human nature. 37 00:05:24.000 --> 00:05:35.000 The capital value of any permanent good, therefore, was the sum of the whole series of rents or incomes it contained discounted at some rate to its present worth. 38 00:05:35.000 --> 00:05:44.000 Dorfman here is quite correct in saying, and this will become key in thinking about the criticism of this theory, 39 00:05:44.000 --> 00:05:57.000 What Federer argued was that time preference is the preference that a person has for a given satisfaction sooner as opposed to the same satisfaction later. 40 00:05:57.000 --> 00:06:04.000 This is a necessary beginning point in the Mengerian conception. You have to start with preferences. 41 00:06:04.000 --> 00:06:12.000 You have to begin with the first primary causal factor that sets in motion everything else. 42 00:06:12.000 --> 00:06:36.000 and again for Menger this is the human mind. Now I think that Dorfman makes an error here, and again we'll talk about this in a minute, when he says that this is the summation or the capitalization of psychic income, 43 00:06:36.000 --> 00:06:48.000 Actually, as we'll show in a few slides coming, Menger has a very robust and correct view of how capitalization works. 44 00:06:48.000 --> 00:06:53.000 So he's not claiming that you can capitalize subjective value. He doesn't actually say that. 45 00:06:53.000 --> 00:06:58.000 Although he does have an overly psychological conception of value. 46 00:06:58.000 --> 00:07:08.000 Okay, so Feder says this about time value. Remember in Dorfman's quote he mentions this concept of time value. 47 00:07:08.000 --> 00:07:11.000 Feder says this about time value. He says, 48 00:07:11.000 --> 00:07:14.000 Time value is the difference between the values of things at different times. 49 00:07:14.000 --> 00:07:20.000 The simplest and clearest case of time value is the difference noticeable in the same thing at different moments. 50 00:07:20.000 --> 00:07:25.000 Is this good worth more now or next week? Shall this apple be eaten now or next winter? 51 00:07:25.000 --> 00:07:29.800 Center. These questions can be answered only after comparing the marginal utilities which 52 00:07:29.800 --> 00:07:36.800 differ according to the varying conditions of the two periods. So this is a key point 53 00:07:37.160 --> 00:07:41.440 of debate. I know it seems a little off topic, but it's a key point of debate in interest 54 00:07:41.440 --> 00:07:46.200 theory, especially the time preference theory of interest. What Feder is saying here is 55 00:07:46.200 --> 00:07:52.200 that if we have a good, any particular good that a person might be valuing, not only can 56 00:07:52.200 --> 00:07:57.300 Even if its marginal utility differ in different uses in the present, its marginal utility 57 00:07:57.300 --> 00:08:02.600 could differ for different uses at different points in time. 58 00:08:02.600 --> 00:08:11.160 And therefore, obviously, there isn't any universal law in motion that would always 59 00:08:11.160 --> 00:08:15.360 ensure a premium on the present use of the thing, right? 60 00:08:15.360 --> 00:08:20.480 It could be that something is worth more to someone at some later date. 61 00:08:20.480 --> 00:08:24.720 Because, as Feder puts it, there are varying conditions, right? 62 00:08:24.720 --> 00:08:29.240 Different conditions under which the thing will be used would make it more valuable in 63 00:08:29.240 --> 00:08:32.440 the future as opposed to the present. 64 00:08:32.440 --> 00:08:38.960 The reason this is relevant is because, again, we'll see in a minute, time preference and 65 00:08:38.960 --> 00:08:44.400 interest cannot be conceived of from the pure time preference theory as the trade of present 66 00:08:44.400 --> 00:08:52.440 Goods for Future Goods, because, well, time preference won't necessarily be expressed 67 00:08:52.440 --> 00:08:54.640 in that kind of a trade. 68 00:08:54.640 --> 00:09:00.400 Okay, so Feder goes on and he says time value then has two different aspects to it. 69 00:09:00.400 --> 00:09:04.920 The one that he's talking about in this quote, which is just this different marginal utility 70 00:09:04.920 --> 00:09:10.740 for use of a good at different moments in time, that we might call, just for clarity, 71 00:09:10.740 --> 00:09:16.580 We might call that the timing of an action, at what time do I take an action, it could 72 00:09:16.580 --> 00:09:20.900 have different value whether I take the action in the present or in the future. 73 00:09:20.900 --> 00:09:25.860 And then Feder says there's a second aspect to time value and the second aspect is what 74 00:09:25.860 --> 00:09:28.500 he calls time discount. 75 00:09:28.500 --> 00:09:35.260 And time discount is precisely this idea of what in the literature later came to be called 76 00:09:35.260 --> 00:09:36.660 time preference. 77 00:09:36.660 --> 00:09:43.720 This is just the premium on a given satisfaction when it's arrived at sooner as opposed to 78 00:09:43.720 --> 00:09:50.940 later or again the discount would be, there's a discount on its later use as opposed to 79 00:09:50.940 --> 00:09:54.160 its sooner use. 80 00:09:54.160 --> 00:09:57.500 So this is what Feder says about time discount. 81 00:09:57.500 --> 00:10:02.380 All the other cases of time value, so he's talking now about the second aspect, can, 82 00:10:02.380 --> 00:10:06.340 by the practical device of substituting the other goods of equivalent value, be reduced 83 00:10:06.340 --> 00:10:11.260 to the typical case of comparison of the same thing at different times. 84 00:10:11.260 --> 00:10:17.220 So Fedders is saying, look, only if we can have an equivalent value in the present relative 85 00:10:17.220 --> 00:10:21.740 to the future would we be able to see the time discount. 86 00:10:21.740 --> 00:10:22.740 So this is his claim. 87 00:10:22.740 --> 00:10:26.860 And we can't do this for goods because we know that it's inherent that the possibility 88 00:10:26.860 --> 00:10:29.900 that goods could have greater value in the future. 89 00:10:29.900 --> 00:10:31.620 So how is this to be done? 90 00:10:31.620 --> 00:10:38.580 And Feder says, well, we can get value equivalents simply by using money in this trade. And he 91 00:10:38.580 --> 00:10:43.100 says this, but two or more quite different things may be expressed in terms of another 92 00:10:43.100 --> 00:10:47.820 thing and so be made comparable. Money becomes the value unit through which different things 93 00:10:47.820 --> 00:10:53.500 may be reduced to the same terms for comparison. With this mode of expressing the value equivalents 94 00:10:53.500 --> 00:10:59.020 of various goods, the interest contract first becomes possible. The comparison of the value 95 00:10:59.020 --> 00:11:04.020 The theory of a bushel of apples with that of a barrel of potatoes or a suit of clothes at the same moment appears simple enough. 96 00:11:04.020 --> 00:11:11.020 When all are expressed in terms of money, the comparison of each with its value equivalent at a later date becomes easy. 97 00:11:11.020 --> 00:11:20.020 So what Feder is saying here is really just an extension of what Mises would point out in economic calculation, his economic calculation argument later. 98 00:11:20.020 --> 00:11:42.020 Money and monetary exchange provides us a common unit of valuing things that we can use to make comparisons of the value of things, both in the present, different things in the present, and Federer is extending that saying the same thing could be true for different things, the monetary value of different things in the future. 99 00:11:42.020 --> 00:11:49.020 So here we have the factor that allows us to isolate the time discount. 100 00:11:49.020 --> 00:12:01.020 And Feder then actually says that he uses this language of the pure time preference, he says in these cases where there's a mix of the time and the timing, the timing and the time discount. 101 00:12:01.020 --> 00:12:09.020 He says there's no element of pure time preference, no degree of preference for the present unit simply because it is present. 102 00:12:09.020 --> 00:12:18.020 So if we were to amend then slightly the time preference cause and effect chain, it would look like this. 103 00:12:18.020 --> 00:12:25.020 What Fedder is calling pure time preference is expressed in demand and supply for present money, not goods, 104 00:12:25.020 --> 00:12:32.020 and that then gives us the pure rate of interest as a result. It isolates this time preference element. 105 00:12:32.020 --> 00:12:39.540 Now, real quickly, let me just mention two alternative theories. 106 00:12:39.540 --> 00:12:45.820 The eclectic theories, notice, already criticized by Boehm-Bawerk, argue that there are two 107 00:12:45.820 --> 00:12:49.900 independent lines that affect the interest rate, right, productivity from one side and 108 00:12:49.900 --> 00:12:52.460 time preference from the other. 109 00:12:52.460 --> 00:12:59.620 One of the founders of this view was John Ray, who is actually Boehm-Bawerk's inspiration, 110 00:12:59.620 --> 00:13:06.260 and also the inspiration for Irving Fisher and the neoclassical view. 111 00:13:06.260 --> 00:13:12.660 Boehm-Bawerk's view is slightly more sophisticated but no better in terms of the pure time preference 112 00:13:12.660 --> 00:13:13.660 theory. 113 00:13:13.660 --> 00:13:18.300 Boehm-Bawerk says something like this, we've got what he might call value productivity 114 00:13:18.300 --> 00:13:23.160 of capital from the increased roundaboutness that can be engaged in with present goods 115 00:13:23.160 --> 00:13:29.220 as opposed to future that affect time preference and then there are the subjective factors, 116 00:13:29.220 --> 00:13:33.220 which is three causes, right, the two subjective factors and the roundaboutness 117 00:13:33.220 --> 00:13:39.220 that affect time preference, which he defines as the exchange of present goods for future goods 118 00:13:39.220 --> 00:13:42.220 and that then they affect the interest rate. 119 00:13:42.220 --> 00:13:46.220 Feder, by the way, criticized Boehm-Bawerk for this, pointing out that 120 00:13:46.220 --> 00:13:50.220 in order to calculate the value of productivity, you have to already know the interest rate. 121 00:13:50.220 --> 00:13:57.220 So, as he called it, as he pointed out, this suffers from the vicious circle, right, this is circular reasoning. 122 00:13:57.220 --> 00:14:07.220 Now, I don't have like a, oh okay, I do have a couple minutes. Let me go on then and just mention some modern criticisms. 123 00:14:07.220 --> 00:14:13.220 Bob Murphy in his dissertation makes a couple of criticisms of the pure time preference theory. 124 00:14:13.220 --> 00:14:19.220 He argues, and again my basic claim here since I don't have time to go through the thing in detail, 125 00:14:19.220 --> 00:14:37.220 But my basic claim is that this criticism is not making this proper Fed or distinction between the trade of present good for future goods, which doesn't isolate the interest rate, and the exchange of present money for future money, which does. 126 00:14:37.220 --> 00:14:41.220 So Murphy says, well there's a dilemma from these two different definitions of time preference. 127 00:14:41.220 --> 00:14:45.220 Sometimes time preference is defined in the satisfaction way, like Fed or Mises. 128 00:14:45.220 --> 00:15:00.220 Sometimes it's defined in terms of present goods, and obviously if it's a term, what he says is that if it's defined by present satisfactions, then it has no connection with the trade of goods, and therefore the interest rate. 129 00:15:00.220 --> 00:15:06.220 And if it's defined as goods, well then it might be a premium of the present or it might be a premium of the future. 130 00:15:06.220 --> 00:15:12.220 And again, Federer bypasses this completely by pointing out that it's the trade of present money for future money. 131 00:15:12.220 --> 00:15:17.220 That's the way the interest rate is expressed and not the trade of present goods for future goods. 132 00:15:17.220 --> 00:15:23.220 And then he says, time preference as a satisfaction is neither necessary nor sufficient for a positive premium of the present. 133 00:15:23.220 --> 00:15:32.220 This is true if you're arguing that the expression of time preference has to be through the exchange of present goods for future goods. That's true. 134 00:15:32.220 --> 00:15:37.220 But it isn't true for money. And so, again, this just misses the mark, this argument does. 135 00:15:37.220 --> 00:15:40.220 And do I have a minute left to do? 136 00:15:40.220 --> 00:15:47.220 Okay, and this is Guido Holzman in the paper he wrote recently criticizing the pure time preference theory. 137 00:15:47.220 --> 00:15:50.220 And again, I just take this as kind of his main criticism. 138 00:15:50.220 --> 00:15:58.220 But it's based upon the same lack of distinction between exchanging present goods for future goods 139 00:15:58.220 --> 00:16:02.220 and exchanging present money for future money that Federer actually cleared up decades ago. 140 00:16:02.220 --> 00:16:09.220 So Holzman says there are two contradictory claims that are made by Mises in his arguments 141 00:16:09.220 --> 00:16:25.220 And Mises says this according to Holtzman because if this is true then only because of time preference would people desire the present, right? 142 00:16:25.220 --> 00:16:27.220 Otherwise they would always choose the future. 143 00:16:27.220 --> 00:16:32.220 But then Mises goes on to say that look, a present good and a future good are not the same thing at all. 144 00:16:32.220 --> 00:16:35.220 They're not the same good. Ice in the winter and ice in the summer. 145 00:16:35.220 --> 00:16:48.220 and again it's true that Mises makes both these claims but again the pure time preference theory doesn't have anything to do with this because it doesn't argue about present goods versus future goods, it argues only about present money in exchange for future money. 146 00:16:48.220 --> 00:17:04.220 The same kind of criticism can be levied at Hultzman's final point where he says that Mises claims that time preference is between two options of choice for the same good so we take a good in the present and compare it to what value we get for the same good in the future 147 00:17:04.220 --> 00:17:08.780 and he says well if we do that then we could get a greater value in the future 148 00:17:08.780 --> 00:17:12.300 right in the present and we wouldn't have interest from this and again that's 149 00:17:12.300 --> 00:17:19.380 perfectly true that could in fact be the case but as I've argued here Federer's 150 00:17:19.380 --> 00:17:24.620 view I think is the correct one where he says no if we want to isolate the time 151 00:17:24.620 --> 00:17:29.140 discount we do this by the trade of money present money for future money and 152 00:17:29.140 --> 00:17:59.140 and therefore we bypass this whole difficulty. Now some of these criticisms have arisen because of semantic confusion, granted, sometimes the pure time preference theorists have used these terms, present goods, trading for future goods, and it has created some confusion on this point, but I think conceptually the pure time preference theory as given by Federer is immune from these criticisms, so thank you very much. 153 00:17:59.140 --> 00:18:01.140 Thank you very much.