Time Preference
Time preference is the rate at which an individual trades off present consumption for future consumption, reflecting the preference for earlier rather than later satisfaction. It is a central concept in the theory of interest and in the analysis of saving, investment, and intertemporal choice.
Definition
Time preference is typically expressed as a rate, analogous to an interest rate, at which an individual is indifferent between a unit of consumption now and a greater amount in the future. A high time preference means a strong preference for present consumption, requiring a large reward to defer it. A low time preference means a willingness to wait for modest rewards.
The concept underlies the analysis of intertemporal choice, in which individuals allocate consumption over time subject to a budget constraint. The rate of time preference, together with the rate of return on saving, determines the optimal pattern of consumption over the life cycle.
Time Preference and Interest
In the classical and Austrian traditions, the interest rate is determined by the interaction of time preference and the productivity of capital. Individuals with high time preference supply little saving, while the productivity of capital determines the demand for funds. The equilibrium interest rate equates the two.
The natural rate of interest, the rate at which saving and investment plans are consistent, reflects these underlying preferences and technologies. Deviations of the market rate from the natural rate are seen as sources of disequilibrium, and the analysis of these deviations informs the theory of the business cycle.
Determinants
Time preference varies across individuals and over time. It depends on factors including age, health, income, and expectations about the future. Younger individuals may have lower time preference, saving for retirement, while those facing uncertainty may have higher time preference.
Institutional and cultural factors also matter. The availability of saving instruments, the security of property rights, and social norms all affect the willingness to defer consumption. The variation in time preference across individuals and societies contributes to differences in saving rates and in capital accumulation.
Policy Implications
Time preference has implications for policy. Policies that affect the return to saving, including taxation of interest and capital income, alter the incentive to defer consumption and thus the level of saving. The design of pension systems, health insurance, and social security affects the incentives for saving and the ability to smooth consumption over the life cycle.
The concept also informs the analysis of intergenerational equity, since the time preference of the current generation determines how much it is willing to sacrifice for the benefit of future generations. The discount rate used in cost-benefit analysis reflects assumptions about time preference and about the appropriate treatment of future generations.
Hyperbolic Discounting
The standard model of time preference assumes exponential discounting, in which the discount rate is constant over time. Behavioural evidence suggests that discounting is often hyperbolic, with a higher discount rate for short horizons than for long ones, implying that individuals are more impatient about immediate trade-offs than about distant ones.
Hyperbolic discounting helps explain phenomena such as procrastination and the preference for immediate rewards, and it has implications for saving, for health behaviour, and for the design of policy. It also raises questions about the consistency of preferences over time and about the appropriate framework for welfare analysis.
Time Preference and Commitments
The inconsistency of time preferences, implied by hyperbolic discounting, creates a demand for commitment devices that constrain future choices. Individuals may seek to commit themselves to saving, to healthy behaviour, or to other long-term objectives, recognising that their future selves may be tempted to deviate.
The design of commitment devices, including automatic enrolment in saving plans and restrictions on early withdrawal, draws on the analysis of time preference and of self-control. The effectiveness of these devices and their implications for welfare are areas of active research.
Determinants of Time Preference
Time preference varies across individuals, reflecting factors including age, health, income, education, and expectations about the future. It also varies across contexts, with individuals exhibiting different degrees of patience for different types of decisions.
The determinants of time preference inform the analysis of saving behaviour and of the effects of policy. Understanding why some individuals save more than others, and how policy can support saving, requires attention to the factors that shape time preference and to the constraints that individuals face.
Policy and Discounting
The choice of discount rate for policy analysis reflects assumptions about time preference and about the treatment of future generations. A higher discount rate reduces the weight given to future costs and benefits, favouring projects with near-term returns, while a lower rate gives more weight to the long term.
The debate about the appropriate discount rate is central to the evaluation of policies with long-term consequences, including climate policy. The choice involves ethical judgments about intergenerational equity as well as empirical assessments of economic parameters, and it has significant implications for the policies that are judged to be worthwhile.