Pure Time Preference Theory of Interest #1

Murphy's Choice: Cooperation, Enterprise, and Human Action says a distinguishing feature of Ludwig von Mises's economics is the pure time preference theory of interest, in which positive interest rates are explained by reference to the fact that people prefer goods available in the present versus the same goods available only at a future date. Most professional economists outside the Austrian School would say that interest is a return to the marginal product of capital, like wages are a return to the marginal product of labor (the productivity theory).

Eugene Böhm-Bawerk in Capital and Interest (1884) classified and critiqued existing explanations of interest. He called the productivity theory of interest a category mistake. His own theory was more or less the time preference theory of interest, although he didn't label it that.

Later Frank Fetter (1904) offered a pure time preference theory of interest. Mises adopted Fetter's time preference theory with a twist. Whereas Fetter regarded the theory as empirical, Mises elevated it to a category of action.

Oddly enough, Murphy says, "After explaining the Austrian approach to interest – which has nothing to do with the productivity of capital per se – we will see how the accumulation of capital goods increases the productivity of labor and land resources, thereby increasing income" (Choice 224).

Murphy proceed to explain what Böhm-Bawerk dubbed the naive productivity theory and and their critique of it. It starts on page 225 of Choice. The entire section is not available using the Look Inside feature on Amazon, but the argument more or less follows Murphy's paper Why Do Capitalists Earn Interest Income?, available online here.

In future posts I will briefly present the Austrian arguments for the pure time preference theory and against the productivity theory, and present my reasons for not being persuaded that time preference gives a full explanation without regard to the productivity of capital.