A Reinterpretation of Chapter 17 of Keynes's General Theory: Effective Demand Shortage Under Dynamic Optimization
Posted: 1 May 2006
This article is an attempt to formalize Chapter 17 of Keynes's General Theory using a continuous dynamic optimization model with perfect foresight. I Present two subjective interest rates: the time preference rate and the liquidity premuim that, respectively, govern the consumption-saving and portfolio decisions. Under optimal household behavior, they are equalized to the market rate of interest. In the monetary economy described by Keynes, however, the equalitly can be inconsistent with the condition of market equilibrium, in which case persistent stagnation occurs. A new analytic method based on dynamic optimization is proposed as an alternative to IS-LM analysis.
Keywords: interest rates, dynamic optimization, liquidity preference, time preference, persistent stagnation
JEL Classification: E12, E40, B22
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