Theory of Interest: Theory of Economic Time (TET) versus Theory of Time Preference (TTP)
 

Theory of Interest

 

Theory of Economic Time (TET)

versus

Theory of Time Preference (TTP)

 

Author: Carlos Alberto Bondone

Thematic Area: Economics

 

It is a real pleasure to present in this distinguished Third International Congress of The Austrian School in the XXI Century (Rosario-Argentina), an advance-summary of my theory of interest.

The Theory of Economic Time shows us inconsistency and not necessity of the time-preference theory, as well as circular reasoning in the concept of originary interest. Mengers background together with the TETs are sufficient to apply the theory of subject value to the theory of interest.

 

Theory of Economic Time

Brief summary of some of the definitions and axioms of the TET:

Definitions:

Economic good: scarce good for the human being.

   Price (p): Information that measures the scarcity of an economic good expressed in quantities of another economic good for which it is exchanged.

Economic time: economic good that presents exclusive characteristics of indirect materialization and permanent positivity.

Currency: economic good that satisfies liquidity.

Currency price (pm):  price of economic goods expressed in currency.

Interest (i): is the price of the economic good time.

Currency interest (im): interest materialized in currency.

Credit: interpersonal exchange of economic time.

Price of credit: by definition of credit its price is the interest. This logical-deductive chain avoids unresolvable arguments on the causalities of interest-price, interest-capital and interest-rate of interest.

Axioms:

Axiom good-price: the mere existence of scarcity shows that there is not economic good without price or price without economic good to which refer to. There is not price on its own; it is the price of an economic good. From this axiom we can deduce two corollaries:

a) positivity of prices: due to scarcity every price is positive.

b) theoretical necessity of the axiom good-price: it is not scientifically consistent to treat a price without specifying the good to which it refers to.

Axiom of indirect materialization: economic time is the only economic good that does not have life on its own; it is always materialized, inexorably, in another present economic good. Time (a day, a month) does not have any economic sense without reference to specific quantities and qualities of goods (kilos of bread) that satisfy human demands of a period of time. The good time comes to life in other goods, and the temporal changes that operate in those goods, price among them, will be the changes operating in the good time, and its price the interest.

Axiom of permanent positivity of i: the permanent fallibility of the human being makes the interest positive by axiom.

Axiom of change: the TET follows Heraclitus, if there is time there is change, if there is change there is time. With time everything changes, and if something changes is because time has passed by. Therefore, a two-dimensional set of knowledge arises, one that is space-time, where space is the entity and time are the changes of the entity. This way, changes in any of their elements define a new set, then, with time everything is different.

Axiom good-owner: there is neither economic good without owner nor owner without economic good. The axiom good-owner is the theoretical support of the double entry bookkeeping system, the most suitable economic-mathematical model.

Axiom of equivalence im pm: when credit is used economic time as currency, im pm.

 

Theory of time preference

 

The theory of time preference tells us, according to Bhm Bawerk, that present goods, by general rule, have more value than future goods when talking about the same quantity and quality. This proposal is the essence and the nucleus of the theory of interest that I am going to present. Mises asserts that present goods are, for man, of greater value than future goods. Time preference is a categorical requirement of the human being. No one can imagine any kind of action in which the nearest satisfaction is not preferred - the other circumstances being not varied - over the farthest satisfaction.    

 

Comparing both theories

 

Now we subject to analysis the components of the TTP in the light of the ones presented by the TET.

 By general rule: this expression looks like a concession of the EA to the macro methodology. The TET attains the objective of universality with its definitions and axioms. 

  when there is equality of quantity and quality: the fact of comparing fungible goods, present and future, introduces the EA into the need of measuring subjective values, difficulty that it tries to overcome by saying that they are useful for calculation purposes, without implying any intention of measuring the subjective. The TET is always within the frame of the theory of subjective value (TSV). Here, it is worth emphasizing the inconsistency in the example of the ice-cream in summer that can not be compared to the ice-cream in winter because they are different goods, since this happens with all the goods with the passing of time.

The economic fungibility of present and future goods compared by the TTP ratifies the TET vs the TTP in three aspects:

1) It is not about the same good, but about goods with specific qualities.

2) Most of the times when man opts between the present and the future, he does not do it with reference to fungible goods: not to consume today for a future investment implies two negations to the TTP: a) he does not compare fungible goods, and b) the simple fact of saving implies to value more the future than the present consumption.

3) The TTP focuses the analysis on the good not on the subject he values. The human being is different at different times, it is not fungible. This circumstance implies a regression towards the theory of objective value (TOV).

Some of Misess expressions such as: they are valued more than , and time preference is a categorical requirement of the human action, lead us to observe:

       a) About positive interest rate: the EA postulates that time preference is generally positive because the observations allow us to assert it. Here the EA forgets two of its methodological pillars when appealing to the macro and the scientific positivism.

We wonder then: in case time preference is not positive, should we deduce that the interest rate will be negative or cero? The TET amends this epistemological aspect and presents us one theory that is corroborated by the mere presence of an economic good.

b) The EA presents as a necessary condition that i > 0, otherwise there would not be an incentive to save and invest. Within this frame it is evident that: 1) negative saving and disinvestment can not be explained, and 2) it belies the principle that all kind of exchange implies improving a position of dissatisfaction, to prefer the future (saving, abstinence, waiting, etc.) to the present is a human action of exchange with the purpose of improving. The fact that the future involves the factor time does not imply that the present is preferred; otherwise goods of greater price would not be sold. Once more, the TET is exempt from this important inconsistency.

Misess determining factor - the other circumstances being not varied - in accordance with the axiom of change, means as far as time does not pass by, in which case we are directly excluding the topic of interest in particular and of existence in general.

 

Circularity in the TTP

Considering that the original interest is the numerical expression of time preference, we can recall Fisher who did not deem necessary to define interest but simply determine it by separating the inflationary component. We can also recall Mises who stated that within the market economy, the original interest is manifested in the discount of future goods by present goods. This is about the existent reason between prices and merchandises, not of a price on its own. And Fetter who also reasoned that the interest rate is a coefficient and not an absolute value (i.e. price)

There is not any worry in the EA to define and/or precise the components of the axiom good-price, let us see:

a) all the efforts were focused on determining a price, a rate of original interest, without specifying with scientific rigor the good of reference.

b) Misess unfortunate assertion says that the original interest is not about a price on its own. This shows that he did not notice the axiom good-price.

c) all the above mentioned takes us to the circularity of reasoning of the original interest rate. The proposed formula separates, from the currency rate of the market, the component of price variation. Indirect materialization transforms this reasoning into circular since time-interest follow the destiny of the good in which it materializes, including variations in its price. In mathematics such circularity is expressed with the presence of a model with more equations than unknown quantities which are validated by the EA.

 

The TET, versus the TTP, before the TOV

The modern approach of interest which arises as a response of the TSV to the TOV emerged like this:

Bhm Bawerk started it with this question: where does the capitalist get that permanent flow of goods from and why he does it without even moving a finger of his hand to create it? Which is the way to derive that income from capital, whichever this way may be without this flow of permanent income exhausting the capital it derives from? The TET points out the following inconsistencies:

1) the flow he refers to is the interest of the TET which owing to the fact of not noticing it, he assigns it to the existence of capital, reason why the EA will find itself committed to the unnecessary task of distinguishing the concept of capital good from capital; 2) there is not any theoretical support in the fact of giving perpetuity to the rent or to the existence of good of any capital, different aspect from the axiom of permanent positivity of interest, situation which I deem Bhm Bawerk tried to refer to but was unaware of the necessary condition of time-interest to achieve the axiom good-price.

Fetter follows the modern approach with his question: why the payments from entrepreneurs to factors should have, within itself, a net surplus, a return of interest? and Hausmann concludes it with his idea: therefore the problem is to find out the reason why the purchase price of the machine does not reach a level that does not leave any surplus it cannot be explained in the absence of a theory of interest. This observation is extensible to all theories of interest previous to the TET, which condition the existence of interest to the result of investments or business in general, aspects that will influence on the price level of the good time, but not on its existence.

In our opinion we do not find anything new in Fetter and Hausmann against Rothbar and Kirzners expressions respectively - about Bhm-Bawerk on his mission to supplant the TOV.

 

Interest as price of currency

The EA stipulated that interest is not the price of currency; it is evident that the axiom im pm was not noticed, prohibited circumstance due to the inconsistencies of his theory of interest and currency the latter basically due to the assimilation of money and currency.

Keynes did work with the supposition that interest is the price of currency, but as he did not realize the implication of the axiom he made two mistakes from which his theory does not have a come back: 1) he generalized the axiom im pm for currency without noticing that with money this axiom is not fulfilled, therefore his currency theoretical proposals either, and 2) in a paper currency world the axiom is valid, then his model based on im   pm   took him to treat them inadequately as independent variables.

Going back to the EA I can say: a) he did not notice the existence of the axiom im pm   that implies the circumstance in which interest is indeed the price of currency; b) if Mises had noticed it, he would have claimed here the validity of his known stance on the impossibility of calculation in socialism (which we object theoretically), and c) the argument between Hayek and Keynes would have been simpler and easier to understand for the latter since his stance is refuted in his own terminological and structural field.

Note: within the frame of the currency theory Austrians discussed interest as the price of money.


The TET and the theory of prices

The exclusive characteristics of economic time, indirect materialization and permanent positivity, involve the necessary participation of interest in the formation of all prices.

We consider that the TET comes to fulfill Fetters wish: a good theory of interest should provide a simple and unified explanation of the value of time, wherever it manifests itself. The universal scientific rigor that the TET brings to the theory of interest extends to all the fields in which it can interfere: price-interest causality, value of capital, theory of distribution, etc.

This necessary participation of time-interest in all prices, together with the axiom im pm, are determining factors of mathematical models; the fact of not noticing it contributed to the loss of prestige of the economy as a science and was plunged into technological excesses (econometrics)  which damaged the theory that supported it.

 

The TET and the synthesis of economic thought

The TET guarantees the full validity of the TSV in the theory of interest and strips it of the metaphysical, ethical and ideological mysticism in which it appeared to be immersed in order to place it in the strict sphere of science.

We can say that the TET brings the economic science back to the macroeconomics field, stripping it of all the macro scaffolding developed in the XX century by the ones who did not assimilate the scientific advance that emerged from the TSV.

We express the above mentioned lines owing to the fact that the necessary and positive participation of interest in the formation of all prices brings the theory of distribution to an end when considering time as one more factor of production, subjected to all the laws of the microeconomics, avoiding the failed path of trying with aggregates to strike a balance.\

It is worth now raising this question: is macroeconomics necessary? Whichever the response would be, it is evident that the TET is not a matter of semantics but perhaps it could deserve the same importance that the TSV had. If it is not like this, we do not doubt that it complements it since it allows to summarize the dilemma of distribution as well as taking it out from the ideological sphere to bring it back to the scientific one, or give a scientific frame to the ideas.

Buenos Aires, July 2010.

 
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