The World Systems Project is going to begin with a thorough examination of Austrian economics, starting with Robert P. Murphy’s outstanding “Austrian Economics Home Study Course”. The plan is to blog my answers to the weekly questions, with posts and book reviews tossed in as I go along.
It should go without saying that the following contains ‘spoilers’, and if you intend on doing the home study course on your own you might not want to read further.
This was an unusually difficult set of questions. It’s entirely likely that I have gotten some of this wrong, and I will update it in the future if I remember to revisit this post.
1 What is time preference?
The willingness to defer present consumption for future rewards; or, the willingness to save money.
2 For Mises, is the existence of time preference merely a psychological regularity?
I believe he said it was a ‘praxeological regularity’ — not just something people do sometimes but something that it is within their nature to do.
As of now I’m not sure how I feel about this claim.
3 If I would rather “consume” a package of fireworks next July instead of today, is that a violation of time preference?
No, it is a kind of time preference. Time preference denotes a willingness or lack of willingness to defer consumption. A desire to use fireworks now would denote a high time preference, or in other words a strong tendency towards satisfaction in the present. But a desire to put off using the fireworks until next year would be an indication of low time preference, meaning you’re content to wait until next year to enjoy them.
4 What is the difference between rent and interest?
Rent is a price paid for temporary use of a good. Interest is a broader phenomenon, and can basically be thought of as an exchange rate between present and future goods. A high rate of interest privileges present goods over future ones by making it more expensive to invest in long-term projects, and a low rate of interest makes such projects more appealing by lowering the cost of undertaking them.
5 Can an investor earn interest just in the loan market?
An investor can earn interest in the loan market, yes.
6 What is Fetter’s theory capitalization theory?
The section of “The Great Austrian Economists” dealing with Fetter’s theory of capitalization was extremely condensed and high-level, so I can’t claim to fully understand it. But I will do my best to answer this question.
Fetter defined capitalization as “discounting the future rents in goods”, which I read as “paying a single sum today equivalent to expected value and discounted because that value lies in the future.” Remember that, all things being equal, people tend to prefer present use to future use.
The price of capital goods arises the same way all prices arise: as a result of individuals bidding on them because of the subjective ranking they assign to the goods. An entrepreneur investing in capital goods makes a profit because when the future “arrives” they can make more from those goods than the discounted rate they paid for them.
These inter-temporal comparisons between present and future uses, present and future goods, and present and future preferences are what give rise to interest rates, not the cost of producing a capital good.
The puzzle of interest rates was a significant one, and Rothbard claimed that Fetter was the first economist to derive an explanation of interest rates from a theory of time-preference.
7 Why don’t Austrians think the productivity of capital goods explains interest?
Because interest rates are a result of time-preference, not the productivity of capital goods. Further evidence for this claim comes from the fact that interest rates don’t only arise in connection with capital goods; basically every type of loan has an interest rate associated with it, for example.
8 Is it accurate to describe the interest rate as “the price of money?”
I’m not sure; I don’t think so. It would be more accurate to describe interest as a kind of exchange rate between present and future goods.
9 Mises adopts a “pure” time-preference theory of interest. But isn’t the rate of interest determined by the supply and demand for loanable funds?
This looks to me like the opposite of the mistake made in assuming that interest is explained by the productivity of capital goods (SEE: question 7), and our answer reflects this fact. We believe that interest rates are a result of time-preference because they occur pretty much everywhere that future consumption is evaluated against present consumption. This includes loanable funds markets, but is not limited to just these markets.
10 Do rich people always save more than poor people?
Let me explain why this question is being asked: if we possessed but a shallow understanding of subjective value theory and time preference theory we might assume that rich people, as a rule, always save more than poor people because they have enough excess wealth to handle any pressing needs such as food, water, and shelter. They might then be said to have the luxury of a very low time preference because they have plenty of money left over to be saved.
This is not the case. We have all heard stories of people working their whole lives on meager funds only to give a vast, saved fortune as an endowment to a university. And of course stories of the profligate rich squandering mommy and daddy’s millions are all too common.