WEBVTT NOTE Authors Forum: The Pure Time-Preference Theory of Interest 1 00:00:00.000 --> 00:00:03.760 This book is a Mises Institute project. 2 00:00:03.760 --> 00:00:06.600 It arose out of the cooperative effort 3 00:00:06.600 --> 00:00:09.160 of the staff of the Institute, who 4 00:00:09.160 --> 00:00:17.040 thought it was timely to bring together in one source 5 00:00:17.040 --> 00:00:20.440 some of the classic works defending the pure time 6 00:00:20.440 --> 00:00:22.440 preference theory of interest. 7 00:00:22.440 --> 00:00:26.960 So the book contains articles by Murray Rothbard. 8 00:00:26.960 --> 00:00:33.160 It has an excerpt from Human Action by Ludwig von Mises. 9 00:00:33.160 --> 00:00:40.720 It has two articles by Roger Garrison and one by Israel Kirzner. 10 00:00:40.720 --> 00:00:42.800 We thought also that this was timely, 11 00:00:42.800 --> 00:00:49.480 because interest rate theory is becoming more widely debated. 12 00:00:49.480 --> 00:00:52.840 And there has been a renewed interest, in particular, 13 00:00:52.840 --> 00:00:55.920 in the pure time preference theory. 14 00:00:55.920 --> 00:01:01.920 It's suffered some criticism as of late that I'll mention in a minute. 15 00:01:01.920 --> 00:01:08.760 So let me just outline the thrust of the pure time preference theory in the context within 16 00:01:08.760 --> 00:01:16.320 which what I'll call the older debate took place, in which Kirzner and Garrison and Rothbard 17 00:01:16.320 --> 00:01:21.000 and Mises are all writing in defense of this view. 18 00:01:21.000 --> 00:01:25.400 So I would put the case this way, the pure time preference theory simply applies the 19 00:01:25.400 --> 00:01:42.400 the Messessian theory of pricing to the determination of the inter-temporal price of money and to think in the most succinct way about Mises' theory of pricing. 20 00:01:42.400 --> 00:01:53.400 What Mises argues is that we as human beings have preferences, so all action stems from our judgments of value that we make in our minds. 21 00:01:53.400 --> 00:02:07.400 And from these preferences we then are motivated to act, and some people wish to, because of their preferences, acquire a good through purchase, and others to sell the good, they have reverse preferences. 22 00:02:07.400 --> 00:02:14.400 And the price emerges that clears the market, so it depends upon the intensity of demand relative to supply. 23 00:02:14.400 --> 00:02:21.400 And in this formulation, Mises insists, and this is really the crux of the pure time preference theory of interest, 24 00:02:21.400 --> 00:02:31.400 Mises insists that preferences are the cause that sets in motion the determination of price. 25 00:02:31.400 --> 00:02:37.400 In response to this claim that, well, what about objective circumstances? 26 00:02:37.400 --> 00:02:41.400 Aren't preferences conditioned by objective circumstances? 27 00:02:41.400 --> 00:02:50.400 Mises said as far back as The Theory of Money and Credit in 1912 that, no, no, this is not the correct way of viewing human action. 28 00:02:50.400 --> 00:02:57.520 and Action, it's actually our mental judgments that determine the influence of objective 29 00:02:57.520 --> 00:03:00.640 circumstances upon our actions. 30 00:03:00.640 --> 00:03:07.960 And these preferences are not, we can't go back to some other prior cause before them 31 00:03:07.960 --> 00:03:09.320 in human understanding. 32 00:03:09.320 --> 00:03:14.480 They are the first cause in the sequence of cause and effect. 33 00:03:14.480 --> 00:03:19.760 So the Peer Time Preference Theory simply takes this insight and applies it to the question 34 00:03:19.760 --> 00:03:23.040 of the Intertemporal Price of Money. 35 00:03:23.040 --> 00:03:27.540 So the argument again just in sketch says we have time preferences, we have a preference 36 00:03:27.540 --> 00:03:33.880 for sooner satisfaction of an end as opposed to a later satisfaction of the same end. 37 00:03:33.880 --> 00:03:39.360 And because of this we act upon these preferences, some people with higher time preferences being 38 00:03:39.360 --> 00:03:44.760 willing to borrow present money in exchange for future money, some people with lower time 39 00:03:44.760 --> 00:03:50.840 time preferences, being willing to lend at a particular interest rate to these high time 40 00:03:50.840 --> 00:03:56.080 preference people, and then just like in regular markets, the market clears depending on the 41 00:03:56.080 --> 00:04:01.760 intensity of time preference, the higher time preference people cooperating with the lower 42 00:04:01.760 --> 00:04:04.060 time preference people. 43 00:04:04.060 --> 00:04:08.340 With respect to the objective circumstances then, that everyone agrees have something 44 00:04:08.340 --> 00:04:12.980 to do with the setting of the interest rate, just like everyone agrees that objective circumstances 45 00:04:12.980 --> 00:04:17.500 have something to do with the price of apples or the price of gasoline, the pure time preference 46 00:04:17.500 --> 00:04:23.460 theory says that the particular influence of these objective circumstances is determined 47 00:04:23.460 --> 00:04:29.940 by the judgments of our minds, just as it is in the general case of pricing theory. 48 00:04:29.940 --> 00:04:37.940 As Roger Garrison likes to put it, the interest rate is determined by time preference alone, 49 00:04:37.940 --> 00:04:47.620 Okay, now let me set this in the context of the debate, and I'll use the phrases here, 50 00:04:47.620 --> 00:04:53.140 the older debate and the newer debate, the older debate that was taking place within 51 00:04:53.140 --> 00:04:57.420 the context of these articles that were written, and then the newer debate that is addressed 52 00:04:57.420 --> 00:05:01.460 in the introduction to the volume. 53 00:05:01.460 --> 00:05:05.900 So in the older debate, in thinking about the schematic I've given you, there was one 54 00:05:05.900 --> 00:05:12.300 One view that said objective circumstances alone determine the interest rate is the productivity 55 00:05:12.300 --> 00:05:19.780 theory of interest that was held by a number of writers that Boehm-Bawerk attacked on this 56 00:05:19.780 --> 00:05:20.780 point. 57 00:05:20.780 --> 00:05:25.500 This, by the way, the analog of this in regular price theory and general price theory would 58 00:05:25.500 --> 00:05:28.260 be a cost of production theory. 59 00:05:28.260 --> 00:05:32.060 These are similar in approach. 60 00:05:32.060 --> 00:05:39.300 A second alternative is the view that time preference and objective circumstances, say 61 00:05:39.300 --> 00:05:43.660 the productivity of capital, mutually determine the interest rate. 62 00:05:43.660 --> 00:05:48.100 They have mutual independent causal effects on the interest rate. 63 00:05:48.100 --> 00:05:52.900 This again is like the mutual determination theory of Alfred Marshall. 64 00:05:52.900 --> 00:05:57.740 So again, Boehm-Bawerk effectively criticized this view. 65 00:05:57.740 --> 00:06:06.140 The third view is that objective circumstances, like the productivity of capital or these 66 00:06:06.140 --> 00:06:13.100 objective things, affects the interest rate independently but through time preference. 67 00:06:13.100 --> 00:06:15.180 This is a somewhat more subtle view. 68 00:06:15.180 --> 00:06:21.380 This is the view that Boehm-Bawerk and Fisher had of the interest rate. 69 00:06:21.380 --> 00:06:26.220 But again, if you think about this in terms of the general theory of pricing, Mises' general 70 00:06:26.220 --> 00:06:30.620 Theory. We see right away that we would not accept this. We would not accept that 71 00:06:30.620 --> 00:06:36.540 there's some necessary determined independent effect of some objective 72 00:06:36.540 --> 00:06:41.780 factor when it changes as it filters through my mind and and leads to my 73 00:06:41.780 --> 00:06:46.760 action. No, no, no. We think just the reverse, right? We think that whatever the 74 00:06:46.760 --> 00:06:50.960 objective circumstances are, it's the judgment of our mind that determines the 75 00:06:50.960 --> 00:06:54.960 and the influence that those objective factors have on my action. 76 00:06:54.960 --> 00:06:58.960 By the way, when we think about how 77 00:06:58.960 --> 00:07:02.960 we do the analytics of price theory, and the same with the 78 00:07:02.960 --> 00:07:06.960 pure time preference theory of interest, 79 00:07:06.960 --> 00:07:10.960 we can, of course, with Sater's Paribas assumptions, do an analysis 80 00:07:10.960 --> 00:07:14.960 where by holding everything constant, like the preference rank constant, 81 00:07:14.960 --> 00:07:18.960 we can see what the influence of 82 00:07:18.960 --> 00:07:23.680 changes in objective circumstances would be satirist paribus but that's not 83 00:07:23.680 --> 00:07:27.400 right that's not the same thing that's an analytical technique that's not an 84 00:07:27.400 --> 00:07:32.840 argument about what is the causal factor behind price or behind the rate of 85 00:07:32.840 --> 00:07:37.000 interest okay so the pure time preference theory then could be put in 86 00:07:37.000 --> 00:07:41.640 this manner given the way I've stated these other alternatives and that 87 00:07:41.640 --> 00:07:45.960 objective circumstances have a dependent effect an effect on the 88 00:07:45.960 --> 00:07:54.960 and the interest rate that depends upon the judgment that the actors make in their minds about these things. 89 00:07:54.960 --> 00:08:04.960 The view of Mises, of Rothbard, of Kirzner, Garrison, and Frank Fetter that I want to turn to now. 90 00:08:04.960 --> 00:08:10.960 Now in the newer debate that's taken place in the last decade, 91 00:08:10.960 --> 00:08:22.960 This debate has been upon the question of semantics in the writings of Mises and Rothbard in particular, in expressing the pure time preference theory. 92 00:08:22.960 --> 00:08:37.960 It hasn't been a debate upon the substance of the theory, so to speak, but just upon the logical conundrums that seem to arise because of the semantics that were used by Mises and Rothbard. 93 00:08:37.960 --> 00:08:45.960 And here, as I tried to point out in the introduction, it's really Frank Feder's work that's the corrective. 94 00:08:45.960 --> 00:08:56.960 Frank Feder actually had a much sounder, semantic expression of the pure time preference theory than either Mises or Rothbard. 95 00:08:56.960 --> 00:09:05.960 And one of the reasons this hasn't been noticed is because Feder laid this out in his 1904 book, Principles of Economics, 96 00:09:05.960 --> 00:09:35.960 that almost none of these other authors read. When they cite Federer, when Mises cites Federer, when Rothbard cites Federer, they always cite his 1915 book, which isn't a new edition of the 1904 book. It's a totally different book. It's economic principles. And the book, as Federer explains in the introduction, was written to address applied questions, whereas the earlier book is his theoretical treatment. And in the 1904 book, Federer 97 00:09:35.960 --> 00:09:42.920 Whoever solves the problems that have been raised in this debate, by insisting that time 98 00:09:42.920 --> 00:09:48.200 preference must be defined just like we define preference in terms of mental judgments of 99 00:09:48.200 --> 00:09:54.600 value, what's fundamental is the ends that we have, the satisfactions that we obtain 100 00:09:54.600 --> 00:09:59.520 through one course of action relative to another and not the goods. 101 00:09:59.520 --> 00:10:04.640 The goods come in the next step of the argument, right, so we have ends and then we have means 102 00:10:04.640 --> 00:10:14.640 and the value of the means comes from the value of the ends. So, if we want to begin at the beginning, we have to begin with satisfactions, with preferences, evaluation. 103 00:10:14.640 --> 00:10:29.640 And so, Feder points this out. And then he says, when we think about the way in which we value goods at different points in time, they can have different, what I'll call, temporal value. 104 00:10:29.640 --> 00:10:37.640 So a good could have a, a given good like a barrel of oil could have a different value today as opposed to six months from today 105 00:10:37.640 --> 00:10:42.640 because people anticipate that the conditions of demand and supply in six months will be different 106 00:10:42.640 --> 00:10:48.640 and what emerges in trade from this are forward prices, futures markets and so on 107 00:10:48.640 --> 00:10:55.640 and as we all know futures prices can be either higher than spot prices or lower or the same 108 00:10:55.640 --> 00:11:03.640 Because we're not dealing with inter-temporal movements here, we're dealing with temporal placement, temporal use. 109 00:11:03.640 --> 00:11:08.640 The moment in time when we wish to use the thing, it can have a different value. 110 00:11:08.640 --> 00:11:15.640 So Federer points out that this is not true of money, that money we can engage in a pure inter-temporal exchange. 111 00:11:15.640 --> 00:11:24.640 Because money is the medium of exchange and therefore doesn't have these different consumer goods uses or producer goods uses that vary with circumstances. 112 00:11:24.640 --> 00:11:36.640 So with money, when we trade it inter-temporally, present money for future money, we're trading just on the basis of sooner satisfaction and later satisfaction. 113 00:11:36.640 --> 00:11:45.640 We've isolated this time preference element in the inter-temporal structure of the interest rate. 114 00:11:45.640 --> 00:11:52.640 And it's this point that answers some of the semantic difficulties that have been raised. 115 00:11:52.640 --> 00:12:04.640 Okay, at this point I'll just say thank you to the Institute for this project. I think it's a very worthwhile project and I hope it adds significantly to the debate on time preference. 116 00:12:04.640 --> 00:12:09.640 So, do I take questions, Mark? Any questions? Yes? 117 00:12:09.640 --> 00:12:16.640 Have you discovered any natural interest rate around which things do you rotate? 118 00:12:16.640 --> 00:12:26.200 Yeah, that is a problematic issue. 119 00:12:26.200 --> 00:12:34.480 Federer and these other pure time preference theory economists don't, they tend not to 120 00:12:34.480 --> 00:12:42.020 discuss the notion of a natural rate in the sense that we would have, say, a normal rate 121 00:12:42.020 --> 00:12:44.520 of profit or something of the sort. 122 00:12:44.520 --> 00:12:52.560 The natural rate is somewhat more of an equilibrium kind of imaginary construct than it is a theoretical 123 00:12:52.560 --> 00:12:54.160 type. 124 00:12:54.160 --> 00:12:58.240 And so you won't find much of that discussion in the discussion of the pure time preference 125 00:12:58.240 --> 00:13:04.760 theory itself because it's not really trying to deal with that particular issue. 126 00:13:04.760 --> 00:13:12.640 That usually comes up in the theory of the business cycle or some more complicated theoretical 127 00:13:12.640 --> 00:13:34.300 Apparatus. Yes. I argue that the only difference is semantic. Mises, I think, has been properly 128 00:13:34.300 --> 00:13:43.980 We criticized for not hewing entirely to the Fedder definition of defining time preference 129 00:13:43.980 --> 00:13:50.580 in terms of satisfactions. Both Mises and Rothbard in some places seem to define time 130 00:13:50.580 --> 00:13:57.580 preference as the preference for present goods over future goods. As soon as you do that, 131 00:13:57.580 --> 00:14:03.300 logical contradictions turn up, precisely on the grounds that I mentioned before. We 132 00:14:03.300 --> 00:14:19.300 We have a difference in temporal value of goods, and so when we're engaged in future trade, futures markets or forward prices, the present prices aren't always commanding a premium, right? 133 00:14:19.300 --> 00:14:24.300 The futures prices can be higher or lower or the same. 134 00:14:24.300 --> 00:14:29.620 And so this seems to create, okay, so what then is the argument about time preference 135 00:14:29.620 --> 00:14:34.300 within the context of this mixing of these elements together? 136 00:14:34.300 --> 00:14:38.500 And it's Federer, and only Federer that I found, that really separates the two elements, 137 00:14:38.500 --> 00:14:40.940 the temporal from the intertemporal. 138 00:14:40.940 --> 00:14:49.700 He calls this time value the temporal and time discount the intertemporal. 139 00:14:49.700 --> 00:14:50.500 Yes? 140 00:14:50.500 --> 00:15:19.500 It's in, I mentioned it in my introduction. We do not have an excerpt from it. We excerpt a famous Federer article from the Rothbard collection on capital and interest, because it was set in the context of the debate. He's talking about Fisher. Federer, in this article, evinces, 141 00:15:19.500 --> 00:15:24.740 Evince's astonishment that Fisher is not a pure time preference theorist. 142 00:15:24.740 --> 00:15:27.700 He thought he was. He thought he was on his side in the debate. 143 00:15:27.700 --> 00:15:30.460 And this is where we get to that third alternative I was mentioning before. 144 00:15:30.460 --> 00:15:36.100 This kind of subtle view that Boehm-Bawerk and Fisher had that objective factors 145 00:15:36.100 --> 00:15:40.020 have an independent effect on interest rate, but only through time preference. 146 00:15:40.020 --> 00:15:44.500 And it took a while for Federer to understand then that Fisher's view was different from his. 147 00:15:49.500 --> 00:16:11.500 When you define it strictly in terms of money, the time preference of money, I start worrying about what kind of money the definitions are in the context, but I guess you're presuming that there is a good sum of money, how much paper money does it get in a slight way? 148 00:16:19.500 --> 00:16:26.080 the difference in the value of a present satisfaction given the same satisfaction in the future. 149 00:16:26.080 --> 00:16:34.200 And so the other components of the market rate of interest like a price premium or an 150 00:16:34.200 --> 00:16:39.380 entrepreneurial element or whatever it might be, we have to have a different analysis to 151 00:16:39.380 --> 00:16:40.380 add all of that in. 152 00:16:40.380 --> 00:16:44.800 So I think the pure time preference theory would apply to any monetary regime as long 153 00:16:44.800 --> 00:16:48.680 As long as people anticipate that the money in use will still be a medium of exchange 154 00:16:48.680 --> 00:16:56.000 in the future, then they can express their inter-temporal preferences with this money 155 00:16:56.000 --> 00:17:00.280 and they can also then assess their expectations that its purchasing power will be lower in 156 00:17:00.280 --> 00:17:06.600 the future or that there will be certain riskiness involved in the exchange of monies or whatever 157 00:17:06.600 --> 00:17:10.560 else they might do in making that trade. 158 00:17:10.560 --> 00:17:12.720 Okay, thank you very much. 159 00:17:14.800 --> 00:17:16.800 Thank you very much.