Liquidity Preference Theory Research Articles

Unconventional monetary policy ante litteram: Richard Kahn and the monetary policy debate during the works of the Radcliffe Committee

The appointment of a Committee on the Working of the Monetary System in 1957 (Radcliffe Committee) in the UK gave the occasion to debate innovative ideas in the field of monetary policy. Many prominent economists participated in the Committee’s works, which ended with the publication of the Radcliffe Report in 1959. Making an exception to the rule of not mentioning individual contributions, the Radcliffe Report claims to ‘follow Professor Kahn … in insisting upon the structure of interest rates rather than some notion of the “supply of money” as the centrepiece of monetary action’. As we reconstruct in the paper, Kahn based his proposals on a conceptual framework, emphasising the link between inflation, wages and aggregate demand and the importance of combining incomes policy and term-structure control in view of achieving external equilibrium, full employment and price stability. One finding of our research is that Kahn’s recommendations regarding term-structure control—with their relevance to the present day—are best understood in connection with his theory of liquidity preference as presented in Kahn (1954). We also find that the Radcliffe Committee, while espousing Kahn’s policy recommendations, surrounded them with so many caveats as to render them de facto inoperative. As we suggest in our reconstruction, this depends partly on institutional considerations and partly on differences of opinion between Kahn and the Radcliffe Committee regarding monetary policy transmission and the causes of inflation.

Insights on endogenous money and the liquidity preference theory of interest

ABSTRACTIt is argued that the debate between “structuralist” and “horizontalist” has long been obscured because of inadequate treatment, in both approaches, of the credit-money supply and of the total money supply. As a result, endogenous money models still have serious limitations today. On the one hand, the bank loan markup and the loan interest rate are exogenous in the horizontalist model, which supposes that they do not depend on the money/liquidity market conditions (as if bank loans did not compete with the existing liquidity). On the other hand, although interest rates are endogenous in the structuralist model, they result from inappropriate treatment of the loan supply and money/liquidity supply. This article aims to remove these shortcomings. It offers a theoretical framework and formal modeling where the creditworthy demand for loans determines the bank loan supply, given the central bank refinancing interest rate, while the total supply and demand for liquidity-money determines the markup and the market rate of interest in accordance with Keynes’s liquidity preference theory. In this framework, the post Keynesian theory of endogenous money and Keynes’s “verticalist” view prove to be analytically complementary.

On the Updating and Reformulations, Added by Adam Smith and J M Keynes, to Aristotle's Universal, General Theory of Economics, Politics, Civics, and Institutions

On the Updating and Reformulations, Added by Adam Smith and J M Keynes, to Aristotle's Universal, General Theory of Economics, Politics, Civics, and Institutions

A Guide to Help Prepare Readers for J M Keynes's A Treatise on Probability (1921)

A Guide to Help Prepare Readers for J M Keynes's A Treatise on Probability (1921)

The theory of endogenous money and the LM schedule: prelude to a reconstruction of ISLM

ABSTRACT Money is at the center of macroeconomics, which makes understanding the money supply central for macroeconomic theory. This paper presents the Post Keynesian theory of endogenous money supply and shows how it is fundamentally different from the conventional money supply theory. The conventional approach relies on the money multiplier and bank lending is invisible. Post Keynesian theory discards the money multiplier and focuses on bank lending which drives money creation. The paper emphasizes the structuralist version of Post Keynesian theory which retains Keynes’ liquidity preference theory of long term interest rates and also recognizes banks are subject to financial constraints that limit their lending activities. The paper then shows how to derive the LM schedule in an endogenous money economy, which is a necessary prelude to reconstructing the ISLM model.

The role of uncertainty in the euro crisis – an application of liquidity preference theory

The world financial crisis triggered a rediscovery of the active role fiscal policy can play as a remedy in such situations. During the euro crisis, escalating funding costs in a number of southern eurozone member states and Ireland have called this strategy into question. One interpretation of the euro crisis concentrated on the public debt trends in those countries. Opposing this view, the main point of this contribution is to elaborate the link between rising interest rates on sovereign bonds in the euro crisis and a major feature of the financial crisis – a subdued degree of investor confidence after the Lehman collapse. Theoretically, this link is developed with reference to Keynes’ liquidity preference theory. The high explanatory power of measures for the degree of confidence in financial markets as well as detrimental effects of fiscal austerity on the evolution of sovereign yield spreads are demonstrated empirically by means of panel regressions and supplementary correlation analyses.

Macroeconomics, Fiscal Policy, and Public Debt: Conflating Myth and Reality

This is the first of six chapters of the penultimate draft of a book titled Public Debt: An Illusion of Democratic Political Economy. The book’s theme is an elaboration and refinement of the early 20th century orientation toward public debt that Antonio de Viti de Marco set forth. As the book’s title asserts, public debt is a misnomer for a democratic scheme of political economy. To declare a democratic polity to be indebted is akin to observing a grin without a cat, to recall Dennis Robertson view of Keynes’s liquidity preference theory. While the entire book develops this claim, this chapter explains how standard macro theories of various types are more myth than reality, and with the mythology obscuring the realities of the domination-subordination relationships that suffuse democratic regimes. To provide an overview of the rest of the book, this essay ends with the book’s Preface.

How Should the Post Keynesian School Define ‘Uncertainty’? 1 The Only Correct Answer Is to Use Keynes’s Own Definition Given in Footnote 1 on Page 148 of Chapter 12 of the General Theory: Uncertainty Is an Inverse Function of the Weight of the Argument

The Post Keynesian, Institutionalist and Heterodox schools of economics have failed for 83 years to discern the definition of uncertainty given by Keynes in footnote 1 on page 148 of the General Theory that was repeated on page 240 of the General Theory. The footnotes on page 148 and 240 of the General Theory are the foundation for Townshend’s summary of the 1937-1938 Keynes-Townshend correspondence, which was that Keynes’s non numerical (interval valued) probabilities and weight of the evidence (argument) from the A Treatise on Probability were the foundation for Keynes’s liquidity preference theory of the rate of interest in the General Theory. Keynes’s reply to Townshend was that there was very little of Townshend’s summary from which he would differ and that Keynes’s theory (“…my theory…”) was the theory presented in the A Treatise on Probability. Nowhere in the 1937-38 exchanges between Keynes and Townshend is there any mention of F.Ramsey’s objections to Keynes theory of logical probability or of the February,1937 Quarterly Journal of Economics reply article in which Post Keynesians claim that Keynes gave a new definition of uncertainty as ‘fundamental uncertainty.'

Capital Theory, Crises, and Business Cycles: The Triangular Debate between Hayek, Keynes, and Sraffa

The paper discusses aspects of the triangular debate between Hayek, Keynes, and Sraffa on economic crises, business cycles and the role of capital theory in an analysis of these phenomena. It is argued that Sraffa was both critical of Hayek's monetary overinvestment theory and Keynes's use of the concept of commodity rates of interest Sraffa had employed in his criticism of Hayek and of Keynes's theory of liquidity preference.

A Economia Monetária e a Fórmula Geral do Capital: preliminar da fissão Marx-Keynes

Resumo: Este artigo apresenta a teoria da tomada de decisão sob condições de incerteza da escola pós-keynesiana e desenvolve uma interpretação específica para a teoria da preferência pela liquidez. É argumentado que o movimento para ativos (financeiros) mais líquidos corresponde ao movimento do capital de atingir valorização sem passar pela esfera da produção e que, assim, o conceito de incerteza como determinante para a preferência pela liquidez e para a taxa de juros pode ser posto em relação à fórmula geral do capital apresentada por Marx.

The Excess Demand Theory of Money

This paper introduces a new monetary theory. A simple model is described in which a central bank sets the interest rate in a way that the excess demand for credits equals the preferred amount of money. It is compatible with the Keynesian liquidity preference theory and the neoclassical loanable funds theory and can be used to explain a series of phenomena. It is very suitable for introductory textbooks.

Demand for financial assets and monetary policy: a restatement of the liquidity preference theory and the speculative demand for money

:Keynes implicitly used the concept of duration to analyze the impacts of expected changes in the price of a perpetual bond and coupon payments that led to his “square rule.” Keynes’s result (“square rule”), derived from the breakeven condition, was just a simplification to illustrate the importance of expected interest changes on the total return of an investor’s portfolio, constrained to money and consols. Keynes’s world is not one of yield, but one of total return, where price and yield form the returns. This paper aims to show that the same breakeven method can be used, but instead of a simple two-asset model (money and a specific financial asset such as consols) this framework can be generalized to take into account a broad spectrum of financial assets including perpetuals, zero-coupon, coupon bearing securities for different maturities and investment horizons, and risk preferences to analyze the impacts of expected changes in interest rates on total expected return. By using Keynes’s breakeven condition and total return analysis, it is possible to generalize this argument for different types of securities (and not just consols) and it follows the approach of chapter 17 of the General Theory. In this paper, I update and extend Keynes’s analysis to allow for different holding periods (or investment horizons) and different financial instruments. When we take into account duration and convexity effects, and given rising expected changes in interest rate, we get an upward sloping demand for securities with short duration relative to investment horizon rather than a downward sloping speculative money demand schedule. In this framework, duration and breakeven analysis play a crucial role in the demand for financial assets as bank’s expectation on rate changes will generate a demand for short (or long) duration financial assets impacting asset prices.

Liquidity Premium Theory: an Empirical Support From Sukuk (Islamic Bonds) Yields and Profits Curves

The need to account for all one-period returns on bonds which are reinvested at the coupon rate and which in turn would lead to percentage increase in the investors’ wealth over a particular investment horizon led to Liquidity Premium Theory. Sukuk (Islamic bonds with profit rates instead of coupon rates) has been found to be similar to conventional bonds and has been used to achieve same objectives, especially in meeting long term needs of lenders “lid borrowers ill the capital market. Therefore, this study examines the relationship between the yields and maturities of Sukuk to see if long term investors who currently dominate Sukuk market are obtaining term premium to compensate them for the risk involved in long term lending. Using extended Heart, Jarrow and Morton (1992) model, empirical result obtained using 2001 -2009 data on Sukuk and employing MATLAB statistical tool on spot and forward profit rates indicate that there is biased expectation by the Sukuk investor:’. The biased expectation was evidence a from the shape of the Sukuk yields and credit curves plotted. This is a plausible confirmation that there is a positive spread between yields all Sukuk. A broad battery of statistical evidences from the term structure of profit rate suggests that there is support, through Sukuk holders’ expectation, for Liquidity Preference Theory.

Financial hierarchy and banking strategies: a regional analysis for the Brazilian case

The aim of this paper is to investigate whether Brazil’s financial system has a differentiated strategy in space. The analysis is based on the theory of liquidity preference, regionally differentiated. In addition, it assumes that the banking strategies are associated with centrality, as defined in Christaller’s central place theory. The analysis used indicators of 2,924 cities grouped according to the type of financial services they provide. In addition, the paper presents an estimation using a dynamic panel data econometric model for the period 2000–08, in order to test if the banking strategies are related to the centrality of the cities.

When are Interest Rates Exogenous?

Paper for a conference in honor of Basil Moore: Complexity, Endogenous Money, and Exogenous Interest Rates, January 7-11, 2004, Stellenbosch, South Africa. Perhaps the most important of Basil Moore's contributions to economic theory is the recognition that the money supply should be treated as an endogenous variable while the interest rate should be taken to be exogenous. The first proposition has been accepted by virtually all Post Keynesians, while the second was more problematic and briefly resulted in rival horizontal and structuralist approaches. This paper explores several issues surrounding interest rate exogeneity: first, what we mean by the term exogeneity; second, which interest rate(s) is(are) directly administered by policy; third, whether interest rate exogeneity is in some sense natural or whether it follows from particular institutional arrangements, and whether it applies over all stages of the business cycle; and, finally, implications arising from adoption of an exogenous interest rate for Keynes's liquidity preference theory and Minsky's financial instability hypothesis.

On Keynes's Criticism of the Loanable Funds Theory

By accepting the claims of the loanable funds theory, contemporary monetary theory distances itself from Keynes's view of the rate of interest as a monetary phenomenon, and overlooks the arguments Keynes used to respond to the criticism of supporters of the loanable funds theory such as Ohlin and Robertson. This paper argues that the explicit consideration of the finance motive and the role of banks in financing investment does not imply acceptance of the loanable funds theory, but instead facilitates the elaboration of an alternative to the loanable funds theory. Associated with this alternative theory of credit is an explanation of the monetary nature of the fluctuations in income and employment, which is different from and more persuasive than accounts based only on the liquidity preference theory.

Endogenous Money: A Note on Some Post-Keynesian Controversies

Keynes's theory of liquidity preference sought to illuminate the essential properties of money under the conditions of uncertainty that often lead to involuntary unemployment. Subsequent Post-Keynesian literature built upon this concept to show that a deregulated financial system could induce phases of endemic financial instability and crises. Keynes's finance motive provides an important starting point in Post-Keynesian theories of endogenous money. This article examines the controversies between two major contending analytical approaches, the Horizontalist and Structuralist schools.

Money as an Institution of Capitalism: Some Notes on a Monetary Theory of Uncertainty

Dillard notes that to consider money as an institution of capitalism means to emphasize that money is an essential element in explaining fluctuations in income and employment. He states that Keynes's liquidity preference theory offers a sound explanation of money as an institution of capitalism. Keynes's explanation is based on a necessary condition, independent of money: the presence of uncertainty. The objective of the paper is to elaborate a different explanation of the role of money, based on Keynes's 1933 and 1937–39 works, according to which the presence of money constitutes the necessary condition to justify the importance of uncertainty.

Centralidade e hierarquia do sistema financeiro brasileiro

O objetivo deste artigo é analisar a relação entre o sistema financeiro e o grau de centralidade do município onde esse está localizado. Para tanto, é realizada inicialmente uma discussão teórica, inédita, que visa analisar como o grau de centralidade pode afetar a forma de atuação de um banco em um local específico, tendo como ponto de partida a teoria da preferência de liquidez e a concepção de oferta de moeda endógena desenvolvida por Keynes. Após essa discussão teórica, será feita uma análise empírica sobre o caso brasileiro. Assim, é proposta uma hierarquia dos municípios brasileiros definida pela hierarquia do sistema financeiro neles existentes. Com base nessa hierarquia, a forma de atuação das agências bancárias em cada nível hierárquico é analisada. O estudo concluiu que o espaço é um importante elemento na definição das formas de atuação do sistema bancário, com consequências visíveis para o desenvolvimento econômico das regiões.

Significance and Affects of Money Demand for Finance Motive at Keynes' Liquidity Preference Theory

The aim of this study is to examine the contributions of Keynes’ Money Demand Theory for Finance Motive to economic literature and starting in new discussions at this framework. In his studies bearing the dates of 1937 and 1938, Keynes has entitled the money demand ,which occurs before the investment expenditures are completed and before these expenditures affect the level of national income at the end of multiplier process, as “Money demand for finance motive’’. By using money demand concept with financial motive, Keynes has stressed rejection of dichotomy, endogenous money supply and the importance of banking system in a stable capitalist economy. Moreover, opinions of Keynes about money demand for finance motive has created several discussions at framework of Post Keynesian and Monetary Circuitist Approaches.