Subjective Time Preference Research Articles

Neoclassical economics on the edge: Fisher, Knight, and the theory of interest in the 1930s

Irving Fisher and Frank Knight had a brief exchange on the former’s “The Theory of Interest”, published in 1930, which culminated in a full book review by Knight in 1931. We assess the episode by recasting Fisher’s interest theory as a maximisation under constraint calculation. After that, Knight’s objections to subjective time preference are examined, as well as his ensuing attack on the Austrian School’s definition of capital. Fisher’s and Knight’s reflections on business cycles, grounded on expectations, delays, and speculation, are assessed in sequence. We conclude by indicating some limitations of the theories of interest formulated by both economists.

Hyperbolic or Exponential Time Discounting Function? Empirical Evidence Using a Conditional Consumption Capital Asset Pricing Model

The main objective in this article is to shed new light on the term structure of subjective time preference rates using a conditional Consumption Capital Asset Pricing Model. Following Samuelson’s (1937)’s suggestion, we analyze the concept of “time consistency”. More precisely, we challenge the relevance of the exponential time discounting function assumption, which leads to a constant subjective time preference rate. First, we develop a parsimonious, consumption-based model of the term structure of interest rates. Second, we test its implications for US monthly data from 1970:4 to 2013:1. We use a bivariate two-factor model of inflation and real consumption (through a VAR-GARCH process) to condition the term premiums of bonds. Our results clearly cast doubt on the assumption of a flat term structure, as implied by the standard exponential discounting function. A decreasing term structure of time preference rates is reported. It is particularly clear for the 1991-2013 period. Our results give strong support for the hyperbolic time discounting function hypothesis and open the way for the hypothesis of time varying time preference rates.

A time-preference and VIKOR-based dynamic intuitionistic fuzzy decision making method

According to the decision information of multi-attribute decision-making problem with fuzzy and temporal characteristics, a dynamic intuitionistic fuzzy decision making method based on time preference and VIKOR is proposed. First, we determined the attribute weights under different time sequence based on intuitionistic fuzzy entropy minimization; secondly, we introduced the time degree function reflecting the decision makers? subjective time preference, and established a multi-objective programming model to obtain time weights; then we used dynamic intuitionistic fuzzy weighted geometric (DIFWG) operator to integrate different time periods of the intuitionistic fuzzy decision matrices; the VIKOR method is used in ranking solutions that takes account of group effectiveness maximization and individual regret minimization, and obtained the optimal scheme that is closet to ideal solution; finally, the feasibility and effectiveness of the proposed method is verified by the example of a technology innovation alliance partner selection.

Renewable Resource Stock, Relative Income, and Consumption Externalities in a Large Open Economy

Renewable resource stock changes are determined by marginal consumption utility for future production. The expected utility is highly affected by the gap between different discount rates on individual’s utility maximization and various social welfare optimal level. In a large economy with big international trade, we show that sustainable development fails to be sustained without social production at a certain level dynamically. Only if the growth rate of theoretical innovation and capital accumulation is faster than the speed of renewable resource stock accumulation, the discounted value of renewable resource can be offset. In this dynamic process, when a share of environmental income exists, some renewable resource with distinguished regional characteristics cannot be perfectly substituted. Thus, the relationship between social subjective time preference of international consumers and the structural growth of economic production factors is argued by the fuzzy hypothesis of Environmental Kuznets Curve (EKC). If we consider international resource consumption utility is proportionally driven by the relative income due to the inertia of “conspicuous consumption”, we show that consumption choice on every unit of renewable resource is deterministically affected by relative capital income and premium of every unit of asset (that can be transferred from renewable resource); and spillover effect of consumption externality generated from saving or consuming every unit of renewable resource for social production determines the convergence of efficient capital accumulation to increase the total social production level if all individual utility is transferable from renewable resource consumption; in this case environmental taxation ultimately burdens on international consumption side.

Consumption-Based Model and the Term Structure of Subjective Time Preference Rates: Empirical Evidence

In this article we develop a parsimonious consumption-based model of the term structure of interest rates and test its implications for US monthly data from 1970:4 to 2013:1. Our main objective is to shed a new light on the term structure of subjective time preference rates. The empirical analysis exhibits two distinct trends for two sub-periods: from 1972 to 1990 and from 1991 to 2013. Our results clearly cast doubt on the assumption of a flat term structure as implied by the standard exponential discounting function. The shape of a decreasing term structure is reported.

Using real options theory to a country’s environmental policy: considering the economic size and growth

The aim of this paper is to consider how the economic size and growth of a country affect its environmental policy under uncertainty in a real options framework. In contrast to the prior literature, this work explicitly takes into account the link between the development of an economy and the pollution state of the environment. Policy implementation is found to be determined by the levels of the economic size and the disutility of the pollution. We illustrate how to apply our method to the implementation of an environmental policy in an actual situation and show with numerical calculations that the optimal threshold is sensitive only to the subjective time preference, while the expected implementation time is affected by other parameters.

OPTIMAL HARVESTING OF FOREST AGE CLASSES UNDER PRICE UNCERTAINTY AND RISK AVERSION

ABSTRACT. . We analyze optimal forest harvesting under mean reverting and random walk timber price and include multiple age classes, forest owners' consumption-savings decisions and risk aversion. This framework generalizes existing studies that assume a single stand and risk neutrality or include ad hoc risk aversion and obtain the result that uncertainty lengthens the optimal rotation. Including planting cost implies that price stochasticity may shorten the rotation period. Under the mean reverting price process, optimal harvesting becomes more sensitive to periodic price level, as compared to the random walk case. Including risk aversion completely changes the harvesting policy in the sense that, if the forest initially consists of just one age class, it is optimal to smooth the age class structure and have more frequent cuttings from younger age classes. With risk aversion, optimal cuttings depend on price level, even under a random walk price and zero replanting and harvesting costs. In addition, harvesting decisions become dependent on subjective time preference and forest owners' wealth.

Term Structure of Interest Rates and Expected Consumption Volatility: Empirical Test of Term Premiums

We test two forms of consumption-based asset pricing model on American bond market data. The first is the standard C-CAPM, the other one is derived from Abel (1999) who refers to an external habit. The term premium embedded in the term structure of interest rate is linked with the conditional variance of consumption growth and is variable through time. Our empirical test confirms that hypothesis. When modeling consumption using an AR-GARCH process, the ex ante out-of-sample value of the conditional variance is shown superior to other conditional measures. Considering both univariate and multivariate frameworks, variable term premiums are positively linked to variable consumption growth expectations. It supports the expectations hypothesis of term structure and the standard consumption-based asset pricing model. However, a significant constant appears in the empirical test which is not present in the standard consumption models, but can be related to the subjective discount factor of the representative agent. It leads to question the commonly assumed hypothesis of a constant subjective time preference and suggests a decreasing term structure of the agent psychological price of time.

Comparison of external costs between dry tomb and bioreactor landfills: taking intergenerational effects seriously

Dry tomb and bioreactor landfills were analyzed with respect to their external costs in an intergenerational cost-benefit analysis in a partial framework which enabled a sounder comparison to be carried out between these two technologies from a socio-economic viewpoint. Obviously, this approach was only a first step for building a comprehensive basis of any environmental as well as fiscal policy in the field of waste management. All external costs are identified and evaluated in three different scenarios, corresponding to a worst case, a best guess and a best case. Obviously, discounting is crucial with respect to an intergenerational perspective. Generation-adjusted discounting (GAD) was applied to take into account equity as well as efficiency criteria, in order to deal with three different types of uncertainties that are decisive in waste policy decisions: a physical uncertainty is captured by introducing our three different scenarios; a macroeconomic uncertainty is taken into consideration by calculating present values using different real growth rates; and a microeconomic uncertainty is taken into account by considering individual peculiarities reflected in their subjective time preference rate. The findings show, that whenever there is a low real GDP growth of less than 1%, the bioreactor is generally superior to the dry tomb (lower present values of external costs). This statement becomes more valid as the growth rate decreases. However, whenever there are high positive growth rates, it is the dry tomb technology which is superior to the bioreactor system.

Subjective Time Preference and Willingness to Pay for an Energy-Saving Durable Good

Summary: Different shapes of individual subjective discount functions were compared using real measures of willingness to accept future monetary outcomes in an experiment. The two-parameter hyperbolic discount function described the data better than three alternative one-parameter discount functions. However, the hyperbolic discount functions did not explain the common difference effect better than the classical discount function. Discount functions were also estimated from survey data of Dutch households who reported their willingness to postpone positive and negative amounts. Future positive amounts were discounted more than future negative amounts and smaller amounts were discounted more than larger amounts. Furthermore, younger people discounted more than older people. Finally, discount functions were used in explaining consumers' willingness to pay for an energy-saving durable good. In this case, the two-parameter discount model could not be estimated and the one-parameter models did not differ significantly in explaining the data.

Conservation Incentives for Consumers

This paper investigates profit-maximizing conservation incentives of a utility, where the interest in conservation results from prices regulated below the marginal costs of supply and where consumers differ with respect to their subjective time preference. Conventional least-cost planning implies that a program should focus on inefficient consumers (those who apply high discount rates). However, this scheme provokes strategic reactions of the consumers. Hence, incentive-compatible conservation schemes-one tied to efficiency, the other tied to electricity consumption-are derived that differ starkly from the above finding and from actual programs.

The Design of Optimal Conservation Programs by Electric Utilities Considering Strategic Consumer Behavior

The practice of utility demand side conservation programs, one of the most topical issues of utility management, provokes strategic reactions of consumers. As a solution of this moral hazard, optimal conservation programs are characterized when the consumers differ either with respect to their subjective time preference or with respect to the level of demand. In particular, we derive incentive compatible conservation schemes that mitigate strategic behavior. These incentives differ starkly from actual programs. First, the costs of conservation may exceed the avoided costs, yet accepting such high costs (at the margin) need not imply a large conservation. Second, such incentive scheme should bypass the inefficient consumers (e.g., the “poor”) but should instead target consumers who act efficiently and have a high demand (e.g., the “rich”).

Is family planning an economic decision?

In most Western countries couples can decide for themselves how many children they want to have and when they want to have them. This means that family size is a choice variable. In this paper we argue that this choice variable plays an important role in economic models. A couple may rationally determine the optimal number of children it wishes to have, but this choice can only be based on expectations. Since children are usually born one by one, the optimal number may be adjusted during the process of total family formation, as a result of the experiences that the parents have with their first children. The timing of the births can result from a rational decision process. However, deviations from this optimal pattern may be caused by a high subjective time preference.

External debt, time preference, and nontraded goods in a two-sector dynamic model of consumption

A number of studies have indicated that one of the consequences of a development process is a rise in the consumers' subjective time preference rate (discount rate). This study first shows that many of the adverse economic observations in developing countries can emerge from a rise in the discount rate. It then demonstrates that the extent of such adverse effects is related to relative shares of the tradable and nontradable sectors in aggregate consumption. A result is that the aggregate dissaving generated by a rise in the discount rate is smaller when the economy's nontradable sector is relatively larger. The results add new dimensions to the allocation policies applied by international lending insitutions in developing economies.

An Interest Rate Shock on a Small Debtor Economy with Installation Costs of Investment

This paper generalizes the Blanchard-Fischer model (1989) for a small open economy with installation costs of investment. By allowing the divergence of the subjective time preference rate and the world interest rate, the model avoids a constant consumption path which is neither feasible nor desirable for a small growing economy. While the divergence does not define an usual steady state equilibrium, the installation costs of investment lead the economy to the point at which foreign borrowing is entirely used for the consumption purpose while avoiding infinite borrowing. The intrinsic dynamic responses of the model to an unexpected world interest rate shock is then analyzed. [F34]