KEYNES'S FINANCE MOTIVE: COMMENT

Abstract

IN the March 1965 issue of this journal, Paul Davidson advances the Keynesian 'demand for finance' motive as a general theory of the transactions demand for money.1 In doing so, he adds what amounts to a major underpinning to both the static and dynamic properties of the generally accepted (i.e. the Hicks IS-LM) macroeconomic model. I shall argue that Davidson's analysis is incomplete, it does not (as he claims) qualify the traditional use of the IS-LM diagram, and it does not (as he further claims) constitute a meaningful basis for macroeconomic path analysis. What follows is intended purely as a criticism of the logical deductions Davidson has drawn from the operation of the finance motive. I offer no judgement on the empirical relevance of the issues discussed. Having denied in both the Treatise and the General Theory that increments in saving and investment can directly alter the market rate of interest, Keynes offered in June 1937 a mechanism by which changes in investment and interest might indeed be related.2 In anticipation of additional investment expenditures, entrepreneurs would raise their demand for money for 'finance', causing a direct increase in the rate of interest. Thus did Keynes prevent interest movements from straying outside of the supply-and-demand-for-money framework established for them in the General Theory,3 while at the same time acknowledging the common-sense notion that greater investment directly creates monetary stringency. In a later paper Keynes generalized this relationship, arguing that the transactions demand for money depends upon the demand for all output, not merely upon planned investment.4 Davidson revives this long-forgotten point, maintaining that the demand for money contains as its own parameters those of the consumption (C) and investment demand (I) functions. Thus any increase in the demand for goods, consumption or capital, is accompanied by a simultaneous increase in the 'entire transactions demand for money schedule' (Li).5 This 'puts additional pressure on the rate of interest'6 and shows clearly that the monetary sector (i.e. the demand