Austrians claim that the interest rate is determined by the time preferences of individuals on the market. But what is the Austrian understanding of how existing interest rates influence peoples' time preferences?
For example, if the interest rate is at a certain level and then increases or decreases, I may adjust my savings/consumption ratio (time preference) because the interest rate has changed. If the interest rate increases, I may decide that it is a good time to start saving more. If the interest rate lowers, I may decide to consume more.
Is there literature around which analyzes this dynamic of time preferences being influenced by the interest rate as opposed to the interest rate being determined by time preference?
Thanks,
Brutus 2.0
Time preference is a value theory. You are talking about price theory, as in how does price affect demand.
Brutus 2.0: Austrians claim that the interest rate is determined by the time preferences of individuals on the market. But what is the Austrian understanding of how existing interest rates influence peoples' time preferences? For example, if the interest rate is at a certain level and then increases or decreases, I may adjust my savings/consumption ratio (time preference) because the interest rate has changed. If the interest rate increases, I may decide that it is a good time to start saving more. If the interest rate lowers, I may decide to consume more. Is there literature around which analyzes this dynamic of time preferences being influenced by the interest rate as opposed to the interest rate being determined by time preference? Thanks, Brutus 2.0
Interest rates represent over-all time preferences, not individual ones. The interest rate is a price mechanism, more specifically the price of time, and it's at equilibrium when it reaches the natural rate (when investment demand intersects supply of savings without monetary disturbances). Now your time preference may be high relative to the rate of interest, and thus, you won't save as much (or maybe not at all). Ceterus paribus, a reduction in time preferences means a higher savings rate (what Keynesians would call a reduction in aggregate demand), and a lower interest rate (shift to the right in the supply curve). It's the same for all prices; they emerge because of consumer preferences, they don't determine them.
This is a question which even I ain't sure of. Different Austrian economists hold different views on this matter. Even the stalwarts of the school, von Mises and Rothbard, hold contrary opinions when it comes to interest rates. While Mises suggests that people save irrespective of interest rates, Rothbard holds that interest rates could influence people's savings plans. To be honest, I am yet to decide on my 'beliefs'.
But I came across something interesting a couple of days back. People in India have traditionally increased their savings, and more so, in the last two decades although interest rates have been fixed at low levels by the the Reserve Bank of India. So interest rates may not actually be influencing people's saving decisions(unless you are gonna have a crazy idea of negative interest rates).
This is an interesting question... There are always multiple factors that influence economy and behaviour. Maybe in case of India, saving rate increased because people become richer? People were very poor, with barly enough resources to support bare neccessities. Maybe they now have something to save? Just a thought...
azazel:Maybe in case of India, saving rate increased because people become richer? People were very poor, with barly enough resources to support bare neccessities. Maybe they now have something to save? Just a thought...
May be, you are right. Developing countries save more because they are increasingly capable of doing it. And I hope you do realize that this adds to the view that people save irrespective of interest rates.
My "educated guess" is: people have strong tendency to save. Even if the interest rates are low, people will still save up to a point. The purpose of saving is to enable future consumption and to remove or mitigate future risks. It's in our nature. However, I cannot prove that. Also, I believe that by raising interest rates you can induce more savings.
It's interesting, when real interest rates hit negative teritory, people generally stop saving in banks, however they turn to other things that is also saving: buying stocks or property.
azazel: My "educated guess" is: people have strong tendency to save. Even if the interest rates are low, people will still save up to a point. The purpose of saving is to enable future consumption and to remove or mitigate future risks. It's in our nature. However, I cannot prove that. Also, I believe that by raising interest rates you can induce more savings. It's interesting, when real interest rates hit negative teritory, people generally stop saving in banks, however they turn to other things that is also saving: buying stocks or property.
Agreed, again! Savings happen in all economies, even those which never had financial institutions like banks.
Even our own Crusoe saved fishes to build nets
Suppose there was a really free market.
If people decide to save money, then interest rates drop. There is surplus labor/capital for others to invest.
If people decide to borrow and build businesses, then interest rates rise. There is less labor/capital for others to invest.
The central bank credit monopoly distorts this process. The central bank price-fixing cartel sets interest rates, and not the free market.
By keeping interest rates below the natural free market rate, this sends a false price signal that it's profitable to borrow and invest. This leads to boom/bust cycles.
I have my own blog at FSK's Guide to Reality. Let me know if you like it.
It's like any other price really. The point to keep in mind is that whereas Robinson Crusoe need only be aware of his own intertemporal allocation of resources in order to calculate his time preference an individual actor in a modern economic, with an advanced division of labour needs to be aware of the market rate of interest and needs to use it when assessing his own value scale. In fact, unlike Robinson Crusoe an actor in an advanced economy can only understand his intertemporal preferences with reference to the market rate of interest, and this is the same with any other price.
However, this is entirely distinct from whether or not the interest rate actually affects intertemporal preferences, it doesn't (it may, but not necessarily).
"You don't need a weatherman to know which way the wind blows"
Bob Dylan
Brutus 2.0: For example, if the interest rate is at a certain level and then increases or decreases, I may adjust my savings/consumption ratio (time preference) because the interest rate has changed.
For example, if the interest rate is at a certain level and then increases or decreases, I may adjust my savings/consumption ratio (time preference) because the interest rate has changed.
Changing your savings/consumption ratio as a result of a change in interest rate does not mean a change in time preference. Time preference is your supply schedule for investment. It is according to your given time preference, that you had changed your savings/consumption ratio when the interest rate had changed.
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