Chapter 13 of the General Theory Does not Contain J M Keynes’s Liquidity Preference Theory of the Rate of Interest: A Study of the Erroneous Use and Abuse of Chapter 13 of the General Theory from R. Hawtrey, D. Robertson, J. Viner, J. Robinson to J. Ahiakpor

Abstract

A major source of confusion about Keynes’s Liquidity Preference theory of the rate of interest is the failure of readers of the General Theory to recognize that chapter 13 is an introductory chapter that lays the ground work and foundations for chapter 15. Keynes’s actual theory is presented in chapters 15. All of the elements are then brought together in chapter 21 in section 4 on pp. 298-299. Keynes pointed out on pp.297-298 of the General Theory that “Too large a proportion of recent 'mathematical' economics are merely concoctions, as imprecise as the initial assumptions they rest on, which allow the author to lose sight of the complexities and interdependencies of the real world in a maze of pretentious and unhelpful symbols.” This is precisely the point made by Keynes against the Marshallian approach of Pigou in his The Theory of Unemployment (July, 1933), where the simplifications of ceteris paribus and partial equilibrium lead to the specifications of functions like y=f(x). Pigou works with such functions that have only one independent variable. He then subjects these functions to extensive elasticity analysis. The result is in “a maze of pretentious and unhelpful symbols that ignore … the complexities and interdependencies of the real world.” The complexities and interdependences of the real world can’t be examined in a model where the demand and supply of money alone determine the rate of interest as specified in a preliminary way by Keynes on page 168 of the General Theory, so that one arrives at M=L(r), a function with only one independent variable. Instead, Keynes incorporates “… the complexities and interdependencies of the real world” with his M=M1 plus M2=L1(Y) plus L(r)=L on page 199 which, when combined with the micro foundations provided by Keynes’s D-Z model of chapters 20 and 21, the consumption function, the investment function, and the investment multiplier, leads to Keynes’s IS-LM(LP) model of chapter 21. This model is fully capable of dealing with “the complexities and interdependencies of the real world”. J. Ahiakpor is the latest in a long line of economists who bases his analysis only on chapter 13 of the GT alone. This approach is, of course, Marshallian in nature. Keynes’s approach in 1936 models multiple general equilibrium and not the partial equilibrium of Marshall or the single equilibrium of Walras’s general equilibrium. The belief that Keynes’s theory of the rate of interest is denoted by M=L(r), as argued by Hawtrey, Viner, Robertson, Robinson, and Ahiakpor, is false. Keynes’s theory of the rate of interest is given by his three mathematical, simultaneous equations presented on pp. 298-299 of the GT. The missing equation needed by the classical school is: M = M1 plus M2 = L1( Y) plus L2(r)[=L;author’s insert]. The equation M=L(r) is not the equation Harrod was talking about in 1935 in his correspondence with Keynes.