Thursday, April 16, 2009

Consumer Time Preference Part Two

Last week I described the nature of consumer time preference in terms of a primitive economy. Today I shall discuss how consumer time preference is regulated in a more fully developed economy.

The key feature of a highly developed economy is the specialization of labor: nobody does everything himself, but rather does one thing very well, in exchange for everyone else doing their one thing very well. A well developed financial sector allows the division of one more economic function: waiting.

For that's what a saver does on behalf of a borrower: he waits, so the borrower doesn't have to. He can forgo leisure and consumption now for the sake of a better tomorrow, without knowing the exact details of how that future comes about. All he needs to know is how much another will pay him for the use of his savings today, and whether that potential borrower is trustworthy.

A civilization which has a higher time preference will have more borrowers than savers. This will result in a high interest rate, rewarding the few people who have a lower time preference, and ensuring that the extra resources made available by savers go only to the most potentially productive borrowers, limiting the impact of that overall high time preference upon the overall standard of living.

A civilization with a lower time preference will tend to have more savers than borrowers, resulting in a lower interest rate. The more effective the entrepreneurs that arise in that society, the higher the interest rate will be... but if the opportunities for innovation are more limited, the interest rate will fall, telling savers that it may be time to spend. Their time preference being low, they are more likely to spend that money on things like education... thus potentially increasing future innovations.

Thus, an unregulated interest rate does precisely what needs to be done: it shapes consumer time preference, rewarding those with lower time preference when overall time preference is high, and signaling when its time for people to take the cause of progress into their own hands.

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