Liquidity Preference is the Second (Missing) Factor in Keynes's Chapter 13 'The General Theory of the Rate of Interest'. The First Factor Was the MEC Schedule for Investment Combined with Consumption Out of Income, Which Determined Savings
44 Pages Posted: 23 Oct 2017
Date Written: October 22, 2017
Nowhere in chapter 13 of the General Theory does Keynes state that his initial, introductory, Liquidity Preference equation determine the rate of interest. He states that there are two factors that determine the rate of interest. Unfortunately, the neoclassical theory of the rate of interest is based only on one of the two factors. It is therefore necessary to discuss the second factor in detail. This is done in chapter 15. Chapter 13 is thus an introductory chapter that introduces the concept of Liquidity preference.
Unfortunately, economists, such as Millikan, Viner, and Hansen, ignored Keynes’s ten pages of analysis and took the L=M(r) equation on page 168 completely out of context, even though Keynes explicitly introduced Y, national (aggregate) income, where Y=C I, so that I=S, as a reason why decision makers would hold money balances on pp.170-171 of the GT.
Keynes’s introductory analysis of the rate of interest was thus reduced to a one liner –L=M(r) - by the vast majority of economists.
Current views of Keynes’s contributions in the GT amount to a jumble of conflicting stories, tall tales, myths, fables, fairy tales, claims and concoctions that have been passed down from the 1930’s. For instance, one fable is that there could never be any IS-LP(LM) model in the GT because Keynes was a partial equilibrium, Marshallian, anti formalist, methodologist who would never, ever, use a formal set of simultaneous, mathematical, equations in any analysis because this would be a Walrasian, general equilibrium approach which Keynes had condemned. The vast majority of these fables are related to phony claims that were spread by Joan Robinson, who, supposedly, knew what Keynes was doing because she was a close collaborator who worked with Keynes in the writing of the GT. Actually, Joan Robinson never knew what Keynes was doing because she was mathematical illiterate. She never collaborated with or worked with him on the writing of the GT. A careful reading of her 1953 contribution, “A Lecture Delivered at Oxford by A Cambridge Economist”, provides all the evidence one needs to support the conclusion that she had no idea about the nature of Keynes’s GT contribution. She was a draft reader who completely overlooked the clearly specified four equation, formal, simultaneous, mathematical, IS-LP(LM) model in the 1934 draft copy of the GT. If she had been able to follow this analysis, then she would have realized that Keynes’s GT is based directly on the IS-LP(LM) model with uncertainty integrated as a shift parameter in chapter 21 in Sections IV, V and VI of the GT. The IS-LP(LM) model, supported by the microeconomic, optimizing, expectations D-Z model of chapter 20, is the central contribution of Keynes’s GT.
Keywords: Harrod, Hicks, IS-LM, Liquidity preference, Patinkin, chapter 15, pp.180-182 of GT, chapter 15, chapter 21
JEL Classification: B10, B12, B14, B16, B20, B22
Suggested Citation: Suggested Citation