Liquidity Preference Theory Revisited - To Ditch or to Build on it?

The Levy Economics Institute of Bard College Working Paper No. 427

34 Pages Posted: 18 Aug 2005  

Jörg Bibow

Skidmore College - Department of Economics; Bard College - Levy Economics Institute

Date Written: August 2005

Abstract

This paper revisits Keynes's liquidity preference theory as it evolved from the Treatise on Money to The General Theory and after, with a view of assessing the theory's ongoing relevance and applicability to issues of both monetary theory and policy. Contrary to the neoclassical "special case" interpretation, Keynes considered his liquidity preference theory of interest as a replacement for flawed saving or loanable funds theories of interest emphasizing the real forces of productivity and thrift. His point was that it is money, not saving, which is the necessary prerequisite for economic activity in monetary production economies. Accordingly, turning neoclassical wisdom on its head, it is the terms of finance as determined within the financial system that "rule the roost" to which the real economy must adapt itself. The key practical matter is how deliberate monetary control can be applied to attain acceptable real performance. In this regard, it is argued that Keynes's analysis offers insights into practical issues, such as policy credibility and expectations management, that reach well beyond both heterodox endogenous money approaches and modern Wicksellian orthodoxy, which remains trapped in the illusion of money neutrality.

Keywords: Liquidity preference theory, interest rate determination, loanable funds fallacy, bank behavior, monetary policy, credibility, liquidity traps, money neutrality

JEL Classification: B22, B31, B41, E12, E43, E52

Suggested Citation

Bibow, Jörg, Liquidity Preference Theory Revisited - To Ditch or to Build on it? (August 2005). Levy Economics Institute Working Paper No. 427. Available at SSRN: https://ssrn.com/abstract=782968 or http://dx.doi.org/10.2139/ssrn.782968

Jörg Bibow (Contact Author)

Skidmore College - Department of Economics ( email )

Saratoga Springs, NY 12866
United States

Bard College - Levy Economics Institute ( email )

Blithewood Rd
Annandale on Hudson, NY 12504
United States

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