The concept of time preference began with John Rae in his work The Sociological Theory of Capital. He tried to explain why some nations are wealthier than others. According to him, the key reason was differences in saving and investment behavior among people, which were influenced by their ability to tolerate uncertainty and delay gratification. Over time, economists expanded this idea to understand why individuals value present consumption more than future consumption. Factors such as risk, uncertainty about the future, desire for immediate satisfaction, and difficulty in predicting future needs play an important role. People often prefer consuming now because the future is uncertain or because they cannot resist immediate pleasure.
Later, Irving Fisher gave a formal economic structure to this idea by explaining time preference as a trade-off between present consumption and future consumption. He showed that individuals make decisions by comparing their current needs with their expected future benefits. This laid the foundation for modern intertemporal choice theory.
Further development came from Paul Samuelson, who formalized time preference mathematically in his famous work A Note on Measurement of Utility. He introduced the concept that individuals try to maximize their total satisfaction (utility) over time, but they discount future utility. This discounting is usually exponential, meaning that future benefits are valued less compared to present benefits.
Neoclassical View of Time Preference
In neoclassical economics, especially in the theory developed by Irving Fisher, time preference is treated as a subjective and exogenous factor. It reflects an individual’s preference for present consumption over future consumption and is incorporated into their utility function. This concept is crucial in determining the real rate of interest in the economy.
The real interest rate is linked to the productivity of capital, meaning it equals the marginal product of capital. Through arbitrage, returns on capital and financial assets tend to equalize (after adjusting for inflation and risk). Consumers decide whether to consume or save based on the difference between the market interest rate and their personal time preference (impatience). If interest rates are high, people are encouraged to save more and consume less; if low, they prefer present consumption.
In the long-run equilibrium, such as in the Ramsey growth model, consumption remains a constant proportion of income. At this point, the rate of interest equals the rate of time preference. Importantly, neoclassical theory argues that interest rates exist because people are impatient (have positive time preference), not the other way around.
Historical Understanding in Relation to Interest Rates
Early discussions on time preference can be traced back to Catholic scholastic philosophers, who tried to justify returns on capital using ideas like risk and opportunity cost. However, they rejected interest on riskless loans and considered it immoral or usurious because they did not fully understand time preference.
Later thinkers improved this understanding. Conrad Summenhart explained that lenders charge interest because borrowers value present money more than future repayment. Martin de Azpilcueta further argued that present goods naturally have higher value than future goods. Similarly, Gian Francesco Lottini described time preference as an overvaluation of present benefits due to their immediacy.
Later, Ferdinando Galiani compared interest rates to exchange rates, explaining how they equate present value with future value even though they are different in nature.
These ideas were finally brought together by Anne Robert Jacques Turgot, who developed a complete theory of time preference. He argued that in lending, what matters is not just the money exchanged but the value of having money now versus the promise of receiving it later. He also linked money supply with interest rates, stating that if the money supply increases and people prefer saving, interest rates may fall while prices rise.
Overall, the evolution of time preference theory shows how economists gradually moved from moral and philosophical interpretations of interest to a more scientific and behavioral understanding of how individuals value time in economic decisions.