High vs Low Time Preference
Hi Plebs,
The concept of time preference is a fundamental principle in Austrian economics, largely developed by thinkers like Eugen von Böhm-Bawerk and Friedrich Hayek. Time preference refers to the rate at which individuals discount the future relative to the present. In other words, it describes how much people value immediate gratification versus delayed gratification.
Individuals with a high time preference place a much greater value on present consumption compared to future consumption. They strongly prefer to have goods and services now rather than later. Conversely, those with a low time preference are more willing to delay gratification and save or invest for the future.
As explained by Austrian economists, time preferences are reflected in market interest rates. Those with high time preferences will be willing to pay higher interest rates to access resources immediately, while those with low time preferences will accept lower interest rates in exchange for delaying consumption. This enables the market to coordinate the allocation of resources across time.
Hayek argued that interest rates communicate important information to producers about the stage of production they should focus on. When interest rates are low, it signals that consumers have a lower time preference and are more willing to save and invest in longer-term production processes. Producers can then justify investing in higher-order capital goods that will increase future productivity.
Conversely, when interest rates are high, it indicates that consumers have a higher time preference and want to access goods and services sooner rather than later. Producers should then focus more on completing late-stage production of final consumer goods.
Crucially, Hayek recognised that this natural coordination facilitated by interest rates is often disrupted by interventions in the monetary system. When central banks artificially manipulate interest rates, they distort the critical signalling function that interest rates play in aligning time preferences with production decisions.
Here are some examples of real life scenarios using high time preference and low time preference:
Jason is 22 years old and just got his first full-time job after college. He is eager to enjoy the fruits of his labour and spend his entire pay each month on things like going out with friends, buying the latest gadgets, and taking weekend trips. Jason has a high time preference - he strongly values immediate consumption over saving for the future. He'd rather live it up now than delay gratification to build wealth over time.
Sarah is a 32-year-old software engineer making 90,000 per year. She could easily afford to upgrade her 5-year-old car to a brand new luxury version, but Sarah chooses to delay that gratification. Instead, she decides to invest that money. Even though her friends are constantly upgrading their cars and buying expensive homes, she resists those temptations. She knows that by consistently investing a large chunk of her pay, the power of compounding returns will allow her investments to grow significantly over the next 20-30 years, enabling her to build enough wealth to eventually retire comfortably.
The key difference is that Sarah is willing to forgo present consumption in order to invest in her future, while Jason prioritises enjoying his money in the present rather than deferring consumption. This reflects their respective time preferences
Understanding the role of time preference is essential for comprehending Austrian business cycle theory and Hayek's insights on the market process. Whether individuals have a high or low time preference has profound implications for how resources are allocated across time and the structure of production in the economy.
Cheers, and onwards with Bitcoin
