Stock and Flow Analysis: Further Comment

Abstract

FELLNER and Somers have commented on my short article' in such a way that I must stress certain observations. They claim that I find no loanable funds theory in the dynamic case. This is not entirely correct. I have followed some routine procedures in setting up dynamic models and can adapt them to contain either a liquidity preference or a loanable funds theory of interest. My purpose is to show that the twQ theories are different in a dynamic framework, and I do not rule out either one in advance. Ultimately the choice between the two theories will have to be based on empirical information. The concept of dynamics proposed by Fellner and Somers is thoroughly unacceptable. Their definitions lead to results that are formally equivalent to those obtained in static analysis, and no number of references to distinguished persons in the field of interest theory will make their brand of dynamics any more interesting or useful. Actually, I have tried to give a more realistic picture of economic processes that yields much richer solutions. I am greatly disappointed at the insistence of Fellner and Somers on what I choose to call a sham dynamics. I must point out that by assuming kg to be an exogenous variable, I am under no compulsion to assume k= ki . This point is made only in the interest of precision since the assumption of Fellner and Somers (kt = kt-1), although unwarranted, plays no essential role in the treatment of the problem at hand. The dogmatic assertion of Fellner and Somers that '.. . in any system, these factors [other than the demand and supply of securities] can affect the market rate of interest only through their effect on the demand and supply of interest-bearing securities closes the door to scientific discussion. This is, self-evidently, the central assumption of the loanable funds theory, but it cannot be used to prove that the liquidity preference theory is identical, for in the latter theory an entirely different assumption is used, namely, that interest is the reward for being illiquid. Thus, the grin has a cat after all. I close with a rhetorical question. What are the structural characteristics of their suggested unique relationship between the excess demand for money and the excess demand for claims? Is it a behavior equation for some group in the economy; or is it a market clearing equation; or is it an institutional equation; or what is it?