What Is Intertemporal Equilibrium?

An intertemporal equilibrium is an economic concept that holds that the equilibrium of the economy cannot be adequately analyzed from a single point in time but instead should be analyzed over the long term.

According to this concept, households and firms are assumed to make decisions while considering the effect that those decisions will have on their finances and business prospects both in the current moment and in the future.

Key Takeaways

  • The Austrian school of economics holds that the economy is in disequilibrium, and only when examining the economy over the long term does it reach equilibrium.
  • Intertemporal equilibrium is a concept by which households and firms are assumed to make decisions based on the effect on their finances both at the current time and in the future.
  • Intertemporal decisions made by companies include decisions on investment, staffing, and long-term competitive strategy.

Understanding Intertemporal Equilibrium

An example of an individual making an intertemporal decision would be someone who invests in a retirement savings program because, in doing so, the individual is deferring consumption from the present to the future.

A similar term, intertemporal choice, is an economic term describing how an individual's current decisions affect the options that are available in the future. Theoretically, by not consuming today, consumption levels could increase significantly in the future, and vice versa. The economist Irving Fisher formulated the model with which economists analyze how rational, forward-looking people make intertemporal choices; that is, choices over time.

Intertemporal decisions made by companies include decisions on investment, staffing, and long-term competitive strategy.

Intertemporal Equilibrium and the Austrian School

In the Austrian school of economics, intertemporal equilibrium refers to the belief that at any one time, the economy is in disequilibrium, and only when examining the economy over the long term does it reach equilibrium.

Austrian economists, who strive to solve complex economic issues by conducting thought experiments, postulate that the interest rate coordinates the intertemporal equilibrium by allocating resources throughout the production structure. Thus, intertemporal equilibrium can only be reached when individuals' consumption and investment choices are matched with the investment being carried out in the production structure. This match, or balance, allows goods to come to the market in the future, in accordance with the time preference of the population.

This is a central tenet of the Austrian School, represented by economists such as Friedrich Hayek and Ludwig von Mises, who believed that the genius of the free market is not that it perfectly matches supply and demand, but rather that it encourages innovation to meet that supply and demand.

Example of Intertemporal Equilibrium

Creative destruction is a term coined by the economist Joseph Schumpeter and is an example of intertemporal equilibrium. Creative destruction occurs, for example, when inefficient firms go out of business. The immediate result is job losses and falling output. However, the failure of firms frees up resources that can be reallocated to more efficient long-term uses. If only the short-term is considered, the result is welfare loss. However, over the long term, the result is intertermporal equilibrium, which is more efficient than subsidizing a failing firm.