Time-Preference Theory of Interest
What Is the Time-Preference Theory of Interest?
The time preference theory of interest, otherwise called the agio theory of interest or the Austrian theory of interest, makes sense of interest rates in terms of individuals' preference to spend in the present over what's to come.
This theory was developed by economist Irving Fisher in "The Theory of Interest, as Determined by Impatience to Spend Income and Opportunity to Invest It." He portrayed interest as the price of time, and "an index of local area's preference for a dollar of present over a dollar of future income."
How the Time-Preference Theory of Interest Works
Different hypotheses, other than the time preference theory of interest, have been developed to make sense of interest rates. The classical theory makes sense of interest in terms of the supply and demand of capital. Demand for capital is driven by investment and the supply of capital is driven by savings. Interest rates change, eventually arriving at a level at which the supply of capital satisfies the need for capital.
Liquidity preference theory, then again, places that individuals favor liquidity and must be induced to surrender it. The rate of interest is expected to tempt individuals to surrender some liquidity. The more extended that they are required to surrender it, the higher the interest rate must be. Subsequently, interest rates on 10-year bonds, for instance, are regularly higher than on two-year bonds.
Neoclassical Views on the Time-Preference Theory of Interest
Irving Fisher's neoclassical perspectives on the time-preference theory of interest state that time preference connects with an individual's utility function, or the degree to which one measures the worth or value of goods, and how that individual gauges the compromise in utility between present consumption and future consumption. Fisher accepts that this is a subjective and exogenous function. Consumers who are picking either spending and saving answer the difference between their own subjective feeling of eagerness to spend, or their subjective rate of time preference, and the market interest rate, and change their spending and saving ways of behaving likewise.
As indicated by Fisher, subjective rate of time preference relies upon an individual's values and circumstance; a low-income person might make some greater memories preference, liking to spend now since they realize that future necessities will make saving troublesome; in the interim, a spendthrift might make some lower memories preference, liking to save now since there is less concern about future requirements.
Austrian Thinkers on the Time-Preference Theory of Interest
Austrian economist Eugen von B\u00f6hm-Bawerk, who elucidated the theory in his book Capital and Interest, accepts that the value of goods diminishes as the need might have arisen for their completion increments, even when their quantity, quality, and nature continue as before. B\u00f6hm-Bawerk names three explanations behind the inherent difference in value among present and future goods: the propensity, in a solid economy, for the supply of goods to develop over the long haul; the inclination of consumers to misjudge their future requirements; and the preference of entrepreneurs to start production with materials by and by accessible, as opposed to waiting for future goods to show up.
Features
- The time preference theory of interest, likewise alluded to as the agio theory of interest, makes sense of the time value of money.
- Different speculations make sense of interest rates, like the classical theory, in various terms.
- This theory contends that individuals like to spend today and save for some other time, so that interest rates will constantly be positive - implying that a dollar today is more important than one later on.
