Video Transcript: The Time Preference Theory of Interest and Its Critics - Jeffrey M. Herbener

This talk on the time preference Theory of Interest in its critics so divided the  time between. Well, I guess just as this topic goes right between the two, first,  just a introductory development of the idea of time preference and its  importance in in economic theory. And then in the second part, we'll deal with  the critics, but we're going to deal with the critics in a positive way, by looking at  how they try to solve the interest rate problem that was posed by Eugen von  Bohm-Bawerk. So he very famously introduced this, this avenue of debate or  argument with respect to the question of the rate of interest. And it's Well, it's  interesting to see how different authors have attempted to, you know, in different traditions have attempted to meet this challenge. How do you, how do you  wrestle with this interest rate problem that was posed by Bohm-Bawerk work?  So that'll be the second half. Now, let me remind you of what we've covered. Up  to this point, covered a lot of ground in economic theory. We've talked about the  capital structure and production processes and law of returns and all these  technical aspects of production. We've, of course, talked about valuing and  imputation of value, so that we see how value moves from the judgments we  make in our minds to the consumer goods to the producer goods, and how all  the different production processes are organized, especially important in the  social setting, in order to direct resources to ends that we value most highly. So  we've covered the pricing and appraisement economic calculation, all of these  aspects of making an argument and showing how the market economy  accomplishes this economizing task. But there's one thing that we haven't yet  done that's really essential to the whole apparatus of explanation of how the  market works, and that is the element of time. And so we'll proceed in the same  way we did with valuing and appraisement, we need to proceed by starting with  the mental judgments that we make with respect to time and what those are.  And you know what the universal principles of valuing with respect to time  happen to be. And then we'll talk about how that move or leads to pricing in the  market. So, so that's the that's the task of the beginning part of the talk. So let's  start by making a basic distinction between temporal aspects of action and  intertemporal so the temporal aspects of action deal with the timing of action.  They deal with the placement of an action in time, the moment that we take an  action. Should I do the action today, tomorrow, the next day? If I'm going to do it  today, Should I do it in the morning or the afternoon, or the evening, so on and  so forth? Right? This is a choice variable for us as human beings. We can, we  can choose to place the action at a particular moment in time as opposed to  another moment in time. Now, why would we do this? Well, obviously we would  do this because we think that there is some advantage. There's some greater  value from taking the action at one moment in time as opposed to another. The  same reason we do any action, right? We see that there are two alternatives,  and one we judge is more valuable and the other less valuable. So we see that,  you know, eating lunch at after this talk is more valuable than eating lunch 

before the talk, because we can hang out with each other and and, you know,  have great discussions. And that, you know, as part of the experience, right, the  conditions under which the action takes place are different at that moment, and  so it's embellishes the marginal utility we get from the act, right, or from the good that we're acting with. So that's the basic idea of temporal allocation. Now, does  the temporal allocation lead to or temporal assessment, does this lead to any  pricing in the market? And well, yeah, sure. It leads to forward prices so people  can speculate or anticipate today what they think the price of a good will be in  the future, or at some moment in the future. And then they can trade based upon their different entrepreneurial judgments as to you know what that future price  will be. So temporal considerations, the judgment that we make subjectively of  what we think the value of something will be at this moment in time versus that  moment are the underlying principle from which we get forward prices. Now  we're not going to deal with forward prices because these are not interest rates,  and the talk is about interest rates, right? This is the whole point of going over  this a little bit, just to see that we can make this distinction clearly between  forward prices and interest rates. But for those of you who are not familiar with  this, this area of economic analysis, forward prices are agreements that people  make today. Two parties will make an agreement today to trade a good at a  price at some moment in the time that they stipulate today. Right? That's called  the forward transaction. That's the forward price. Now, what we know about  forward prices is that they lead, they lead to temporal efficiency in the allocation  of the good so let's say today we have a futures market in oil, and a lot of the  speculators think that oil is going to become more scarce. You know, geopolitical happenings will occur, and the oil will be cut off from Iran or whatever, and you  know, in the next few months, and then, so the oil price is going to be sky high in six months. And so they've got, they've got this six month. You know, the  expectation of this price way up here in six months, and yet, today it's down  here, right? And so if they make, if they can make forward contracts with each  other, then that price becomes public, just like the spot price, it becomes a  public, public knowledge, right? And now, if we've got this price sky high up  here, that seems to be what the speculators are anticipating. And today's price  down here, then the actual then the people are actually involved in the  production and allocation of oil will know to allocate the oil into the future. So  they'll just build up stores of it, right, and not sell it today. They'll reduce the  supply today, hold it off the market and deliver the supply in anticipation. They'll  deliver the supply in the future, when the price is higher. This arbitraging will  bring the prices together, which means we've got a more efficient allocation  temporal. Now, of the good we've moved it from where it's lower value to where  it's higher valued in time. This is part of the efficiency of the market, okay. But  aside from that, we won't go into any more about forward transactions and this  temporal allocation, because time preference, our topic doesn't deal with 

temporal allocation and the timing of goods. It deals with a different aspect of  time, and this is how we define time preference. Then it's the satisfaction of an  end sooner is preferred to the same satisfaction later. So that's how we define  time preference. And we'll deal with some of the nuances of the definition and so forth as we go along in the second half, where some of the critics come in. But  here we'll just stick with this is the definition. This is the preferred definition, if  you will. And as Ludo von Mises emphasized, this idea of time preference, then,  is embedded in the human condition. This is not a psychological disposition that  some people have, like being impatient or something like that. Impatience, of  course, could, or psychological factors could affect the rate of our time  preference. So that's the different issue, right? But the but the existence of time  preference, of always preferring a sooner satisfaction of a given and to a later  satisfaction is embedded in human nature, by the way, the companion principle  of this we've already seen, right? We didn't put it this way, but the very idea of  preferring more of a good to less of a good is bound up in the finitude of the  human condition. It's bound up in the scarcity of the human condition. We must,  in fact, prefer more of a good to less of a good. That there can't be exceptions to this. This is embedded in the human condition. The same is true of time  preference. Because we're temporal beings, it must be the case that we always  prefer the sooner satisfaction to the same satisfaction later. This is just  embedded in the nature of being temporal. So this is the point right time  preference, then, is not a like an ancillary thing. It's a fundamental feature of all  human action, just like preference is it's important to grasp this point. Uh, time  preference. Then if we want to say this in a slightly different way, it would mean  that there would be a premium that we would place on the present the present  satisfaction is preferred to the future satisfaction. And so there's a premium that  we would place on the present satisfaction compared to the future. And then,  since this is part of the human condition, it it, it's involved in all instances of of  action, well, that have a time dimension. I mean, one might imagine action that  has an insignificant time dimension, where time preference might not be  relevant. But aside from that, it's always involved. We're always assessing the  trade off of alternatives, not just in terms of our preference for one thing for  another, but also in terms of our time preference. This is a element of all of all of  action. The other thing to stress here at the very beginning is that, like  preference itself, time, preference always forward looking. We're always  assessing, anticipating the value that we'll obtain from one alternative versus  another in our preferences. We're always assessing the sooner satisfaction  versus the later satisfaction of something with respect to before we act right with respect to the future. How it would work out if we take one course of action  versus another, then we get so what? How does this manifest itself on in  pricing? Well, this generates, then what Mises likes to call the originary rate of  interest, or what we might or simply call the pure rate of interest. So the pure 

rate of interest, then would be important in determining intertemporal allocation  of things. The time structure of production, then is the most important application of time preference. This is not a temporal question, right? When should I  produce the steel or something? It's, it's the structure of the stages of production and how they're how they're organized. And we mine iron and produce steel,  and then, you know, manufacture parts for automobiles and then assemble the  car. Will, Will this? Will this structure production? How much time will it take?  Will elapse between the start of the production process and the consumption of  the good, right? It's an inter temporal question. Okay, so we get, we get the  manifestation of time preference in the market economy would be what, again,  we'll call the pure rate of interest. So we can trace the pure rate of interest back  to the judgments of the human mind. So we gave this schematic. Remember on  Monday, the first line then is the was the first part of the schematic where we  said, you know, their preferences. And then people, based upon their  preferences for things, would have demand for goods and supply of the goods.  And then when they meet and trade, the price would emerge that clears the  market. So, so that's the top line that we've covered already. So the same  argument would be applied, then to time preference. Some people have more  intense time preference, what we call higher time preference. They want present satisfaction more urgently than other people, compared to future satisfactions.  And some people have less intense time preference. They have lower time  preference, as we say. And so these two people, two groups of people can meet and mutually satisfy their time preferences, the low time preference people can  lend to present money to the high time preference people, and both of them  have their preferences satisfied, then the borrowers are willing to pay interest  rates that The lenders are willing to accept and we get mutual satisfaction. So  the pure rate of interest would would be established at the point that clears the  what we call the time market for the trade of present money for future money.  This is how the the argument would run out. Okay, we'll look at some other  details of this in a minute, and then on the next line, I just want to remind you  that the pure rate of interest then would be the discount, the discounted  marginal revenue product of factors of production. So when entrepreneurs are  considering, how much am I willing to pay today to hire this worker who's going  to work for me and generate, you know, help generate some output in the future  that I can sell, they'll want to know how physically productive is this worker.  They'll want to know what revenue will be generated by this physical  productivity, the marginal revenue product. And if they're going to pay in  advance, of course they they're going to discount their payment so they're going to. The revenue from the sale of the output in the future, but they're going to  have to pay the worker now, let's say over the next year, before the output is  sold. So the demand that entrepreneurs have for factors of production if they're  paying in advance, if they're paying upfront, before the output is sold, would then

be the discounted marginal revenue product. And this, again, we had on the big  schematic on Monday, but, you know, we didn't go into the details of that  particular element, right? What determines the demand that entrepreneurs have  for factors of production? Then the prices of the producer goods, the prices the  factors of production would be determined by the interplay of the supply and  demand to have the owner. We have the workers who own the their labor, and  they offer the labor, and we have the entrepreneurs who are demanding it based on their estimate of the discounted margin of revenue products, and then the  factor prices, the wages would emerge to clear that labor market. So you can  see that the there's an interest return built into production. This is the point the  entrepreneur is always assessing the giving up of present money to pay for the  factors of production, in anticipation of getting future money from that investment right by selling the output eventually to the consumer so that so that's a basic  element of this pricing structure. Okay, so this is how it would look like in the  again, what we call the time market, or what Murray Rothbard calls the time  market, we had the high time preference people who are demanding present  money, borrowers, and then low time preference people who are lending or  supplying the present money. And then they just come together in markets. The  standard argument and the market, they trade at the market clearing price. I  remember the argument here is that they trade at the market clearing price,  because that's the price at which all the preferences of the people involved are  satisfied, and so that price is superior to any other price. And so people are  aiming at that, right? They're imposing that, or setting that, however you want to  say it. So this is what we determine, the pure rate of interest. Notice in the pure  rate of interest, just like the price of any good is is completely determined by  subjective valuations. Given our circumstances, right, we're always in certain  circumstances of action, but given that the the existence of the price and its  level and so on are traceable back to nothing, but how people subjectively value action within their given situation. That's it. This is what the argument of time  preference and its relationship to the rate of interest the Austrian tradition says.  Okay, now another thing we want to mention here is that, and this becomes  important again in the debate the critics. So we want to emphasize this, the  intertemporal trade, this trade of present money for future money is always in  money, not in goods. There's no intertemporal trade that people engage in in  kind, in barter goods. We don't make loans in apples or men's dress shoes or  auto factories or hopefully you see right away why we wouldn't do this. Well,  there's some maybe even more obvious reasons why we wouldn't do this, but,  but the because, you know, these goods are not a general medium of exchange, right? We just prefer that, but, but there's a sort of somewhat hidden theoretical  reason why this is so. If we, if we were to try to, if people were to try to make  intertemporal exchanges in kind in goods, then they would not be there would  be no assurance that they could separate out in this intertemporal trade the time

preference element of their trade from the temporal elements. What if we tried to make lending and borrowing in oil well? But then if we do this, we've got the  problem that when the loan is going to be paid off in the future, the oil could  have a different price, right? Because the consumption or production demand for it, the conditions of it are varied from where they are today. And so we can't, we  can't then make a pure intertemporal trade with goods, because we couldn't be  sure that we were doing this. But we can with money. This is because money is  neither a producer good nor a consumer good. It's the medium of exchange and  a unit of the medium of exchange is equally serviceable with every other unit.  Just like I wouldn't care which dollar bill I or I guess it'd be a $5 bill that I take to  buy a cup of coffee in the morning. I don't, I don't have a differential preference  for one over the other, right? They're completely equally serviceable every unit  of money, and so every unit of money, even intertemporally, has this equally  serviceable character to it. Now, again, we'll see there are nuances to this that  we have to chase down but, but hopefully you can see the there's something  different here. There's something special about money that allows a  intertemporal trade to be done in money, isolating that this time preference  element, isolating the pure rate of interest. Now, now again, their nuances that  we'll chase down in just a minute on this. Okay, so this is the this is the point.  Now, this is a point of debate, and again, we'll take up the some of the points as  we go through the second half. Okay, so then we want to, we want to emphasize this, this additional point, and I make sure we're completely see the scope of the argument here by breaking down the time market into its basic components. So  if we think about the categories of people lending present money in exchange  for future money, we can break down the the time market into two basic  subcategories, their credit markets. And as Murray Rothbard says, These are  credit transactions where we have an overt or explicit loan that's made. And then the credit markets can be further subdivided into consumer loan markets and  producer loan markets. And then consumer loan markets could be further  broken down as they would be in a, you know, in kind of a practical application  into the various goods that are bought with the borrowed money. So we have  mortgage markets for people who buy houses. We have auto loan markets,  right, buying cars. We had general merchandise markets and credit card  markets and so on. And a similar thing for producer loans. So we would have,  you know, prime we had a prime interest market. We would have collateralized  loans, bonds that could be offered, right? And so on and so forth. So, so that  that's how we would give a topology theoretically, to provide a framework for  explaining all of this diversity within the within the credit markets, right? And then there's a capital structure. So as I suggested already, entrepreneurs advance  money to owners of the factors of production, and for this, they need to earn a  rate of interest. Otherwise they won't advance the money. They would just lend it out on credit markets, right? they're in business, and so they need to generate 

this rate of return for making the investment. And we've seen already how this is  done. They obtained this interest return by paying the workers and the factor  earners, the discounted marginal revenue product of their factor. And then when  the good is sold, they earn the marginal revenue product, right? They earn the  full monetary value of the productivity of the worker, and they pay the worker the discounted value they because they're lending the worker money in advance. So this is the idea of, you know, where the interest rate comes, comes from in the  capital structure. And the other point here that I have on the slide is that the pure rate of interest then would be uniform across all there'd be arbitrage again, that  would make just like there we talked about the arbitrage in the forward prices.  There would be arbitrage across all the different investable activities that would  keep the pure rate of interest the same across all all of these different investable projects. Again, we'll talk about a nuance with respect to that in a minute. But if  entrepreneurs could earn 10% by, you know, investing their funding into, let's  say oil, shale oil, and 5% in, you know, just regular pool oil, or whatever they call it, then they would begin to shift their investment away from the low interest to  the higher interest areas, right? And again, this would bring the interest returns  in those two areas together. As they bid more for the factors of production,  they'd raise their price and shrink the net income and so on. So this is just,  again, the normal process of efficiency in the allocation of resources in the  market economy. Uh, okay, so that's so we need this detail in order to again  proceed. And now let's get to this final point on the time preference. This kind of  introductory material on time preference, and this is what I mentioned. I was  mentioning before, about the nuances. Okay, so we have this notion of the pure  rate of interest that is the manifestation of time preference. But the market rates  of interest, as we've already seen, aren't always the same. So mortgage interest rates aren't the same as credit card interest rates. AAA, corporate bond rates  aren't the same as junk bond rates, the rate of return on fracking is not the same as the rate of return on running a bakery and so on and so forth. Well, where  does all that diversity come from? Then, if we said before that arbitrage tends to  make the pure rate of interest the same, okay? Well, it comes from other factors, obviously, that are peculiar to these different classes of investments. And so  again, Ludi von Mises has a nice presentation of this in human action, where he  says, it's not just the pure rate of interest, but it's also the duration of the  investable project, right? So longer duration investable projects tend to  command higher interest rates than shorter ones, because people time  preferences are more readily satisfied in shorter as we said before, sooner as  opposed to later, right? So if you're going to convince people to lend to you for  even later pay back, the premium is higher. This would be the argument. And  second, there's entrepreneurial uncertainty. So these different lines of  investment can have different degrees of entrepreneurial difficulty and of  anticipating the future accurately. And if they do, then the funds that are lent, you

know, the entrepreneurs that are borrowing funds or plowing their own funds into these projects that are more uncertain have a greater degree of uncertainty, so  we don't really know quite as well if it's going to pay off. Would have to  command higher interest rates to draw the funds into those lines of activity than  lines of activity where entrepreneurial uncertainty is more manageable. Then  there's what Mises calls the price premium. The price premium comes from  Kantian effects through monetary inflation. So you've heard explanations of this  already, right? We get a monetary inflation comes into the hands of people in the economy, particular people, in particular places a particular time, and so they  can buy the things that they want, and the prices of those things will rise first,  and then the producers of the goods whose prices are rising will get more  income, and then they'll buy the things that they want, and the prices of those  things go up and so on, and with sort of ripples throughout the economy. And it  could be that a an entrepreneur is producing in a market where he's close to the  first users of the money, if so, the after the fact, the rate of return is going to be  higher than than he you know otherwise, right? And so this is what Mises calls  the price premium. And then finally, there are unanticipated changes in the  purchasing power of money. This is where we get to the nuance I mentioned  before about the equal service ability of a unit of money across time. It's quite  obvious that there's equal service ability of a unit of money across markets in  the present, right? But that's because the purchasing power of the unit of money would have to be the same. Because I'm either going to I'm going to spend it  right now, but I'm gonna spend it on this good versus that good. Purchasing  power of money over time doesn't have to be the same, does it? The purchasing power of money in the future again, could be lower or higher than it is in the  present. So if I'm gonna make a loan contract, I have to take account of that,  right? I have to think in my in my mind, and make an entrepreneurial judgment,  what I think the purchasing power of the money is going to be when I'm paid  back, compared to the purchasing power of the money that I'm offering today,  right now, if people, as Murray Rothbard pointed out, if people, if all people in  the market, in the time market, If everybody in the time market perfectly  anticipates the future purchasing power of money, then there'll be no  unanticipated element. There'll be no purchasing power element in the interest  rate, because they'll act today perfectly in response to that, to that instance,  right? And this, this premium, then would part of it would be this fourth part  would be washed away. But if it's unanticipated, then it will remain right. So  some people have better anticipation of what the future pursing power of money  is going to be than other people. Then, then this premium will rise in the in the  market rate of interest, so in periods of. Higher rates of price inflation. Market  interest rates tend to be higher because they have this premium built into them,  because not everybody in the market anticipates that the correct degree of price inflation. So that that's another nuance, right? So that's the manner in which 

then the purchasing power of money is corrected, so to speak, the differences in the purchasing power of money are accounted for in the assessment that we  make intertemporally about taking present money and paying back future  money, or lending present money and receiving back future money. Okay, so  now let's go on to the to the second part. This is BohBawerk's interest rate  problem. And so this is the problem. Why is the price of a capital good not bid up by investors or entrepreneurs to equal the sum of its lifetime marginal revenue  products? If I know that, I can buy a plot of land. Let's say that, you know,  generates, it's a farmland, and it generates an income of $10,000 I've got 100  acres or whatever, and it generates that income. And I think, well, it's going to  keep generating that income as long as I, you know, tend to it properly. I  husband the land properly. It's going to take, it's going to generate that income  for me next year and year after. And year after that, and the year after that, year  after that, year of that year for that so why, as an investor would I not pay the the full future revenue stream to get that, to get that land today, that's the that's the  question, right? We know that the price of the land will be finite, not infinite, as it  would be if there were no interest rate, the price of the land is going to be finite.  But why? Why doesn't you know? So if I can buy the land, if I can buy this 100  acres for $120,000 and it generates all and everybody knows it, or has a  reasonable expectation there. You know, there's a sort of reasonable spectrum  of expectations with respect to what it's going to do in the future. Why doesn't  another entrepreneur just step in and outbid me and pay 130,000 140,000 or  150,000 why not? What stops them from doing this? Right? That's the that's  very puzzling questions. It is a very excellent way of proceeding on this line of  inquiry about the interest rate. So the to put the point, the other way around, the  owner of capital then receives a permanent income from owning the capital.  Once they once they own the capital, they get, they get this income that just  comes to them. Right? It seems to be anomalous element in the market. It'll  seem to be just, it's a surplus income. And why should anybody get a surplus  income? And you can see that the Marxists jump on this, right? So we'll, we'll  deal with them as a one, one critic. Now we've already seen the answer to that  Bohm-Bawerk gave and that the Austrians give PT. PT is pure time preference  theory. So the pure time preference theory says that the surplus income comes  from the discount if I'm going to buy the land I have to pay today, and if I pay  $150,000 today, well, I could have invested the $150,000 in credit markets on  interest, and I could get this income, right. I could generate that income. So if I'm going to pay $150,000 to the land today, I have to generate the same income.  So that's the idea, right? We pay the entrepreneurs pay only the discounted  marginal revenue product stream to buy the capital good, but they earn the  marginal revenue product just like they do for all factors of production. So this is  not puzzling or anomalous or anything. This is what happens. This is one area  where the capitalist entrepreneur generates income. Okay, now let's okay, go to 

the critics. So this is the exploitation Theory of Interest. You may remember in  reading some Austrian literature that Bohm-Bawerk smashed this to pieces  right? The labor theory of value and the exploitation Theory of Interest was Dead from the neck up after boom Bohm-Bawerk wrote about it in the in the late 19th  century. As he pointed out, this argument is based upon the this fallacious labor  theory of value, which we won't go into the fallacies of it. And as Bohm-Bawerk  pointed out, labor is, in fact, paid its full value. They're not. It isn't exploitation  that's just wrong. Headed to think this, and we can see this quite readily in a,  you know, a simple thought experiment, where we ask the question, what if late  a. What if the workers, instead of being paid up front, what if they just waited for  their pay? What if they waited until the good was sold and then got their pay?  Then how much would it be? And the answer is, well, then it would be its full  marginal revenue product. Or to put the case slightly differently, what if they took what if workers took their upfront pay and then lent it out on interest until the  good was sold, then they'd have the full marginal revenue product of their of  their services, right? So this is not exploitation. This is just, it's lending and  borrowing, right? The workers have higher time preference. The entrepreneur  has lower, and they're just mutually satisfying their time preferences. And there's no exploitation involved, okay, the productivity theory. The Productivity theory  was advanced next in chronologically against the time preference theory. And  very famous examples of this, Irving Fisher, provided some of this. And then  there were others. Paul Samuelson Frank Knight, are famous critics of the pure  time preference theory on this ground. And they say, Wait a minute. You know,  capital just generates a physical flow of output in the future. Capital is physically  productive, and the interest rate is just reflecting that physical productivity. And  so, so it's not based on subjective value or anything like that. It's just, it's just a  manifestation of the physical productivity of capital. Now, Bohm-Bawerk, again,  if you know the Austrian literature, you know Bohm-Bawerk spent an entire  volume of his three volume work on capital and interest, debunking all of the  different variations of these theories, right? There's like, I don't know, 20  variations of the productivity theory. He goes through them all and smashes one  by one, right? So we can't go through, you know, do all that work. So this is kind  of a truncated version of this. So the first point then to make about, well, the  example. Let me back up just a second. The example that Irving Fisher gave  was, let's suppose we have, we have this sailor, these sailors on a ship, and  there's, they crash on an island, they're stranded. And then he goes through  different scenarios of goods that they have. Sheep is one of them. And so that,  that's the example I've given here. And then hard tack is another, and then figs  is a third. And you can see what he's going for. He's saying, Look, if you have  sheep that reproduce, and then the sheep flock gets bigger, 10% bigger every  year, you've got productivity, and you would have a positive interest rate, a  positive real interest rate, right? If you have hard tack that never disintegrates 

and doesn't self reproduce. Well, then you have a zero interest rate in a hard  tack world, because there's no productivity, right? If you have a fig world, well,  the figs deteriorate and you'd have a negative interest rate. Is what he says. He  says, you know, this is obvious and factual result of the the physical attributes of of the stipulated conditions. But as Bohm-Barek points out, this misses the the  point entirely. Of course, nobody doubts that there's physical productivity, and  there could be then, you know, a physical improvement over time, or physical  status, or whatever physical deteriorate, deterioration. But none of, none of that  has anything to do with the rate of interest. Again, to take a real example, let's  go to the land example. Again, land is like the sheep. The problem with the  sheep example is it's a one good economy, right? And so you get into all sorts of problems trying to work out the logic of a one good economy of which there  aren't any so right in the real world. So if you have land, and land is perpetually  productive, the rate of return that's earned on an investment in land, though, is  independent of that. Right? It's completely independent of its physical  productivity. It depends only on people's time preferences. It depends only on  what people are willing to advance as present money to obtain the future  revenue stream that would be generated by that by that physical productivity. It's just a monetary question, right? And so if it were physically more productive, the  entrepreneurs would be willing to pay more upfront to buy it. And so the rate of  return then would be moderated from the real productivity. Or, as my example  puts it, this is CV is capital value. So if we have land, the capital value, since  land is indefinitely productive, we're assuming the marginal revenue. It's just  calculated as the marginal revenue product divided by the interest rate. So if we  had a land site that generated $10 worth of value at a 10% interest rate, it would have a capital value of $100 entrepreneurs would be willing to pay $100 up front to get a revenue stream of $10 a year at a 10% rate, over 10. Return. If the  going rate of return is 10% if the going rate of return is 5% then they're willing to  pay $200 to get a 10 a $10 return every year, the capital value adjusts, in other  words, to the rate of interest, so that the so that every investable project  generates exactly the same rate of interest. This is the problem with productivity  theories, or the, at least the fundamental problem, okay, what about eclectic  theories? This is one variation of the neoclassical theory. This is like the  Marshallian scissors that we mentioned briefly in demand and supply analysis  for goods, demand is preferences and supply is cost of production, and the two  sort of codetermine the price of a good. This is Marshall's view. And so here's a  Marshallian application to time to interest rates. They say demand, yeah,  demand for borrowed money is based on time preference, but supply is based  upon the productivity of capital and to the two jointly determine the rate of  interest. Now hopefully you can see right away that this has got to be mistaken.  If the productivity theory itself is wrong, then this has to be wrong, because the  productivity of capital is, whatever its physical productivity, its value productivity 

is always determined by the going rate of interest. And so to argue this way,  you're actually engaged in the fallacy of the vicious circle, right? You're arguing  in a circle. So this is no good. We can toss this out right away. Here's Bohm Bawerk's attempt to explain the rate of interest. And Bumb-Bawerk makes a  critical misstep that Ludwig von Mises noted. He reintroduces productivity into  the argument as fundamental. And so his argument is yes, yes, it's time  preference. It determines the demand and supply for he called it present goods,  not money, as we've been doing, present goods, and that determines the rate of  interest. And there's subjective factors that enter into time preference, just like  we have been saying, right? A person could have high time preference because  they're, you know, they're impatient for whatever reason, psychologically, or  whatever it might be, although, Bohm-Bawerk's subjective factor is a little bit  more psychologically, psychological claims, than than what I've been claiming.  But the but the basic problem is this value productivity. You can't have value  productivity until you know the rate of interest, as we've already suggested, we  don't know the value productivity of capital. We don't know what the monetary  rate of return is going to be by investing in capital until we know the rate of  interest. Of interest. And so when Bohm-Bawerk's theory, again, is no good by  introducing that element, he's given up any kind of cause and effect argument  for the rate of interest. This theory is also a neoclassical theory that has been  advanced by several authors, and this is the idea that weighting is a factor of  production, and the interest rate is the payment to the factor of production. We  call weighting. Now, by the way, when I first heard this theory, I thought, Well,  okay, you know that we can, kind of, I can sort of accept that premise, if, but I  thought What they meant was, in the theory was that waiting meant actual time,  then it sort of, You know, seems plausible. Maybe there's something else wrong  with the theory, but that's not what they mean by waiting. They define waiting as  this supply of present money. Waiting is just lending. Okay, well, okay, well,  okay, then then the argument just sort of falls apart, right? Because if what they  mean by waiting is lending, then time preference determines waiting, and then  waiting determine, yeah, determines the rate of interest, along with demand for  for present money, the supply of present money and the demand for present  money determine the interest rate. If we want to call the supply of present  money waiting, okay, well, that's not really a very, you know, a big advance on  economic insight, right? That's not very helpful. Actually. The other thing that we  might say against this, you can do this as a homework exercise. This will  scramble your brains. If you try this, I guarantee you try to figure out what the  marginal physical product of waiting is. If you define weighting as the supply of  credit, what then? Because all neoclassical economists say that, you know,  agree with the Austrians, the they have the marginal productivity theory of factor  pricing, right? So if waiting is a factor of production, is price has to be  determined by the marginal productivity theory. Of factor pricing. Okay, so that, 

I'll leave that as a homework assignment. Okay, Bob Murphy has some  criticisms of the pure time preference theory. This comes from his dissertation,  and he argues this way. He says, Look, they're in lit, and he's quite right about  this. In the literature, there are two definitions of time preference. One that we  gave at the beginning is in terms of satisfaction, then another that we saw  Bohm-Bawerk uses, and sometimes you see this also in Mises. It's present  goods versus future goods. So, so this seems to be this, are they the same, or  how are they related? Right? We have this problem. So Murphy hits on this.  He's quite correct to point this out. Professor Murphy says, as a present  satisfaction, then then it's right, time preference always means a premium of the  present. So we can all agree with that. That's that's not controversial. But as  present goods, if we define time preferences present goods, well then it doesn't  necessarily mean that there would be a premium on the present, right? There's  no to have a to have a subjective premium on the on the present doesn't  generate a an interest rate in and of itself. And to have present goods will  generate a price, but it it won't be connected to the premium that we have  subjectively, there's no reason to think that the two are connected. And he's  quite right about this. We've already seen the solution to this. Why this is not a  very effective criticism. It's because we're not trading present goods for future  goods in the in the time market. We trade present money for future money. And  money does, in fact, provide a template upon which we can impress our time  preferences purely right, without this temporal aspect. And so his second  criticism is based upon the same kind of distinction. He says, Look time  preference as a satisfaction could generate a premium of the present, but it's  neither necessary or sufficient, because a premium of the present could arise  from different marginal utilities of the good, right? Just as we had noticed before  when we talked about the timing of things and the time preference premium  could be overcome if we value if we have a marginal utility of the future good  that's much higher than the present good. He's quite right about this, but what  he overlooks is the fact that this is precisely the reason, theoretically, that people make time preference related exchanges, intertemporal related exchanges in  money and not in goods. Okay, so that, so again, this criticism sort of is beside  the point, and then Dr Holtzman also has criticisms based upon the same kind  of fundamental distinction between time preference as a satisfaction and time  preference as present goods versus future goods. So both these criticisms  misfire because they don't recognize that time preference is always expressed  in money, present money versus future money, never goods. So Professor  Holtzman's argument is more intriguing. He says the larger stock of a future  good is preferred to a smaller stock of a present good. And because of this, only time preference could explain why we take the present amount right? That's one line of argument, one way to put it. But then he points out that Mises and others  in this line of time preference argument also say that a good in the present is a 

different good from the good in the future. Well, if that's true, then the first line of  argument is not is not correct, is it? It's not certainly correct, right? It doesn't  follow logically if the future good is different from the present good, so what if we have more of it? Maybe it's a lousy good, right? It's a different Good, okay, it  could be lousy. He's quite right about this is quite right. But again, intertemporal  trade is not in goods. It's present money for future money. And so it eliminates  this, this problem that might arise. And then he says, he again, takes another  stab at this. He says, time preference is between two options of choice for the  same good. He says, this is Mises View, but he's thinking of a good. He's  thinking of a good, like an apple, any good, in other words. And then he says,  Well, look, you know, if that's his view, then he's got a big problem, because the  value of an apple six months from now can be can be different, right? Is not, it's  not expressing just time preference. It could be different because of the timing of the apple. You know, the circumstances of consuming the apple in the future.  Quite right about this and Mises is sort of not as clear as he could be on this  point, he just sort of interchangeably used this expression of present goods for  future goods. But if we stick to money, present money for future money, then this problem goes away. So again, I don't think this is a definitive. Criticism against  the time preference theory, but it's very helpful. These criticisms by Professor  Murphy and Professor Holtzman have been very helpful in sort of clarifying,  there's much more work to be done, by the way, for you young scholars in this  area of clarifying issues related to time preference and interest and financial  markets and so on and so forth. So at that point I'll stop. Thank you very much.