OK, let me begin by saying I have great respect for Bob Murphy and Bob Wenzel, having learned much from them both. I like to think of Murphy as stronger in theoretical economics, and Wenzel as excellent in predictive economics. So don’t get me wrong, guys, a mistake here and there mars not their established top notch reputations.
But Wenzel missed the boat, at least in one part of his critique where he writes that there is a “bogus difference between ‘liquidity’ and ‘time preference.'”
Loyal followers of our blog will remember that of course there is a difference, a huge one, with Mises and Hazlitt accepting the one and rejecting the other. Here’s a bit of Hazlitt on liquidity preference:
Before we go on to explain the theoretical reasons why
Keynes’s liquidity-preference theory is wrong, we must first
point out that it is clearly wrong. It goes directly contrary
to the facts that it presumes to explain. If Keynes’s theory
were right, then short-term interest rates would be highest
precisely at the bottom of a depression, because they would
have to be especially high then to overcome the individual’s
reluctance to part with cash—to “reward” him for “parting
with liquidity.” But it is precisely in a depression, when
everything is dragging bottom, that short-term interest rates
are lowest. And if Keynes’s liquidity-preference were right,
short-term interest rates would be lowest in a recovery and
at the peak of a boom, because confidence would be highest
then, everybody would be wishing to invest in “things”
rather than in money, and liquidity or cash preference
would be so low that only a very small “reward” would be
necessary to overcome it. But it is precisely in a recovery
and at the peak of a boom that short-term interest rates
And here once again is Mises laughing off the liquidity preference theory:
It regards interest as compensation
for the temporary relinquishing of money in the broader
sense—a view, indeed, of insurpassable naivete. Scientific
critics have been perfectly justified in treating it with con-
tempt; it is scarcely worth even cursory mention.
Hazlitt is very enthusiastic about time preference, as can be seen in Chapter 15 of his classic Failure of the New Economics. To save space, we kill two birds with one stone, by quoting Hazlitt quoting Mises on time preference:
Mises espouses a pure time-preference theory:
Time preference is a category inherent in every human
action. Time preference manifests itself in the phenomenon
of originary interest, i.e., the discount of future goods as
against present goods. . . .
OK, I think we have established that the two are different, or at least that Mises and Hazlitt thought they were, one being the right theory, the other the wrong one. But what exactly is the difference?
1. Liquidity preference only applies to money. One loses the possibility of using ones money by lending it to someone. If I lend it out for a year, I might need it badly before the year ends.
Time preference, on the other hand, applies not only to money, but to everything. I’d rather have a pizza now than next year, and a house now rather than next year, not just money.
Why is this important? I confess I don’t have clarity on this point. Perhaps someone can enlighten me in the comments.
[EDIT: I think I found something, see my post here: deep-stuff-on-interest-rates]
2. Liquidity Preference Theory and Time Preference theory lead to opposite conclusions. When times are hard, at the depth of a recession, it stands to reason that people will be reluctant to part with their money, as Hazlitt pointed out [see above]. So interest rates should be highest when times are hard according to Liquidity Preference theory.
But according to Time Preference Theory it makes sense that they be lower. In the depths of a recession people are not looking to party every day, they are looking to save their money for the difficulties they see lying ahead. In other words, they are more than willing to delay consumption for later, which according to time preference theory will yield a low interest rate.
OK, I confess that this is deep stuff here, and could use some knowledge. But I think I’ve made my case that the distinction between the two theories is not bogus.
Hit the books, Bob Wenzel.