Question

1. Give a classical account of the relationship between time preference and interest rate.

Answer 1

Time preference is the intensity of our desire to satisfy our wants now over satisfying our wants in the future. Low time preference means that we are able to hold off on our consumption for now, in order to consume more in the future. High time preference means that we want to satisfy our wants immediately.

According to Carl Menger and Ludwig von Mises, “the driving force of interest rate determination is individual’s time preferences”. The public were allotted a higher valuation to present that is the current goods versus future goods which mean that the present goods are valued at a premium to future goods. Similarly, according to Mises, “Satisfaction of a want in the nearer future is, other things being equal, preferred to that in the farther distant future. Present goods are more valuable than future goods”

Therefore, Time preference and market interest rates are really important because they coordinate production in time.