Analysis of the Yield Curve

Courtesy of Sandeep Jaitly @

One of the greatest conflicts that prevented the establishment of a credible theory of interest was that between the time preference & productivity schools. Fekete, looking back to Menger, synthesised the two schools to produce the only coherent & complete theory of interest.

Looking back to Menger’s observation of the existence of a bid/offer spread as opposed to a monolithic price, Fekete combined the productivity and time preference schools via marginal analysis with marginal time preference and marginal productivity of capital. Ludwig von Mises admitted only time preference – and not marginal time preference at that – as the basis for the formation of interest. This was an oversight and not in keeping with the Menger’s established form of marginal analysis.

Space – via marginal productivity of capital – and time – via marginal time preference – were united in Fekete’s theory of interest. Marginal time preference is expressed via the marginal bond holder. The marginal bondholder is the first to refuse to exchange gold coins for bonds in view of the (bid) rate of interest falling below their time preference. The time preference of the marginal bondholder is defined as marginal time preference. In a similar fashion, marginal productivity of capital is expressed via the marginal entrepreneur. The marginal entrepreneur is the first to refuse to exchange bonds for capital goods in view of the offered rate of interest being above their (potential) productivity.

Marginal analysis coupled with Menger’s original observations, can be extended further to determine the theoretical shape of the yield curve under an unadulterated gold standard: discussion of which occupies the faculty of The New Austrian School & Fekete Research. Would it be flat? Would it have an upward bias? Continue reading