March 14, 2005
Caplan on time preference

Bryan Caplan at EconLog last week criticized what he called the “myth” of Misesian “time preference” theory.

Problem #1 with Bryan’s critique: there are at least two senses of “time preference”. Bryan starts out with a quote from Mises that expresses what we might call the idea of “absence of categorical time indifference”: the idea that, if we see you consuming now, you must not be indifferent at every margin between consuming now and consuming indefinitely later. Bryan rightly observes that diminishing marginal utility over dated consumption is sufficient to explain why all consumption is not indefinitely postponed. What Bryan doesn’t see is that DMU is consistent with Mises’s view, not a contradiction of it. (Mises was, in fact, a pioneer in explaining diminishing marginal utility in ordinalist terms.)

Problem #2: Bryan seems to think that the scarcity of present goods, relative to future goods (in a world of positive growth, obviously) is a sufficient explanation for the premium on present goods. He offers an analogy:

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.

If we were to take this line seriously, we would eliminate the subjectivist revolution in economics: any relative price can be explained by scarcity (read: real cost) without reference to preferences!

It can be imagined (although I doubt that it’s true) that people have the same preferences for gold as for silver, only the world happens to be more abundantly endowed with silver. The problem with considering this case analogous to present and future goods is that the greater abundance of future goods isn’t a happenstance. It’s endogenous, the result of our saving and investment practices. Future goods are not manna from heaven. But a world where future income is exogenous seems to be exactly the world Bryan imagines:

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?

Bryan rightly points out that growing income “gives even perfectly patient people a reason to increase their demand for current consumption.” That is, even a person who is indifferent between an extra dollar today and an extra dollar tomorrow, when today and tomorrow are equally provisioned, will prefer the extra dollar today when tomorrow is already better provisioned.
Bryan then concludes:

Of course, none of this means that time preference does not exist. It does. But you don't need it to explain the existence of interest. Diminishing marginal utility does that job.

No, DMU doesn’t do that job at all. DMU doesn’t explain why, even when today and tomorrow are equally provisioned, the market characteristically values a dollar today higher than a dollar tomorrow. That’s a fact that we need time preference to explain.

Posted by Lawrence H. White at 11:13 AM in Economics  ·  TrackBack (35)

The statesman who should attempt to direct private people in what manner they ought to employ their capitals would not only load himself with a most unnecessary attention, but assume an authority which could safely be trusted, not only to no single person, but to no council or senate whatever, and which would nowhere be so dangerous as in the hands of a man who had folly and presumption enough to fancy himself fit to exercise it. -Adam Smith

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