§4. Impatience as Determinant of the Interest Rate

Certain characteristics of The Rate of Interest led to the unfortunate deduction on the part of many readers94Edition: current; Page: [468] of that volume that I regarded impatience as the sole and complete determinant of the rate of interest. While I have tried in this book to forestall similar misinterpretations of my theory, and while it does not seem possible to me that any reader could now charge me with being a pure impatience theorist, it will serve a useful purpose to consider the various factors involved in this question.

We may draw upon Professor Fetter's writings for a clear statement of the issue between the productivity theory and the time preference theory of interest. He states positively that time preference is the sole cause of interest, although he assumes that physical productivity is essential to the emergence of value productivity.95 He declares that his theory was new in assigning priority to capitalization over contract interest and in giving a "unified psychological explanation of all the phenomena of the surplus that emerges when undervalued expected incomes approach maturity, the surplus all being derived from the value of enjoyable (direct) goods, not by two separate theories, for consumption and production goods respectively."96 [Italics mine.]

I have no criticism to make of this statement of the operation and effect of time preference so far as it goes. It seems to me to coincide sufficiently with the treatment which I have presented under the first approximation. There incomes were assumed to exist and to be rigidly fixed in amount and in time without our bothering to ask how they were produced. Nature offered no options to substitute one income stream for another. One could modify his income stream only by borrowing or lending. Edition: current; Page: [469] Under the hypothetical conditions so assumed, time preference would cause interest without help from any rate of return over cost. But such assumed conditions never do or can exist in the real world.

Of course a constant rigid physical productivity, yielding unchanging physical income streams, is contrary to the observed facts of life, just as unchanging time preference for each individual at all times and under all conditions is an absurdity. In real life men have the opportunity of choosing among many optional income streams. When such opportunities exist, time preference alone does not and cannot explain the emergence of interest. As a mathematical problem, the rate of interest would under the conditions of the second or third approximations be indeterminate without introducing the influence of the opportunity or productivity factor.97

Productivity, that is, the possibility of increasing the present value of the income stream, introduces new variables which have to be determined as a part of the interest problem and every new variable requires a new equation or condition.

It happens that, for lack of applying this mathematical principle, writers have often thought themselves in greater disagreement on the explanation of interest than they really were. Wordy warfare has been waged among the various productivity theorists and the capitalization Edition: current; Page: [470] or time preference theorists. Each combatant seems to think that he and he alone has hit upon the correct and complete explanation and that, therefore, any other explanation is necessarily false. As a matter of fact, both productivists and time valuists are substantially right in their affirmations and wrong in their denials. Thus, theories which have been presented as antagonistic and mutually annihilatory are in reality harmonious and complementary.