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Keynes' General Theory of Interest: A Reconsideration (Foundations of the Market Economy Series) | 
 enlarge | Author: Fion Maclachlan
Publisher: Routledge
Category: Book
List Price: $190.00
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Rating:  4 reviews
Sales Rank: 3473547
Media: Library Binding
Edition: 1
Pages: 200
Number Of Items: 1
Shipping Weight (lbs): 0.7
Dimensions (in): 8.5 x 5.5 x 0.9
ISBN: 0415079349
Dewey Decimal Number: 332.8201
EAN: 9780415079341
ASIN: 0415079349
Publication Date: March 26, 1993
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Product Description
Fiona Maclachlan revives Keynes' largely discredited liquidity preference of interest theory and provides an original and rigorously reasoned reformulation of it. Maclachlan reaches the innovative conclusion that liquidity preference can explain the existence of interest on its own, while time preference and capital productivity cannot. The book draws on the methodological tenets of the Austrian school and is grounded firmly both in the history of economic thought and in real world economic institutions.
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Interest and Uncertainty... June 11, 2008
James F. Mueller (St. Louis, MO USA)
2 out of 2 found this review helpful
This is a book about Keynes' theory of interest. Keynes made a remarkable contribution to economics by arguing that interest can be explained by the uncertainty of the future. Very broadly, Maclachlan argues that liquidity is desired because it provides one with a wide range of options in an uncertain world. The author also identifies two motives as being responsible for the preference for liquidity: the precautionary and the speculative motive. The precautionary motive enables one to cope with unforseen and suddent emergencies, while the speculative motive provides one with the means to "grasp" profitable opportunties when they arise or are discovered. The possession of wealth with little liquidity makes it difficult for individuals to exploit either motive successfully. From this it follows that a premium must be paid to those willing to surrender liquidity. Maclachlan discusses several reasons for this at great length. For example, individuals have a strong desire to be more rather than less certain about the purchasing power of their assets; there are transactions (and search) costs involved in exchange; and so on.
Maclachlan next tackles several objections and criticisms that have been made against Keynes' liquidity preference theory of interest. Most common is probably the bootstraps argument which says that it is circular to use the existing interest rate as a standard by which to measure the degree of preference for liquidity which in turn determines the interest rate. Maclachlan separates general from particular liquidity preference and concludes that a general preference for liquidity avoids the infamous "bootstrap argument."
The most important chapter, however, is the one on "intertemporal coordination." There she argues that savings and investment do not in any way coordinate interest rates because of the existence of easy credit policies. For example, it would seem that in an economy in which banks are able to create credit, the distinction between savings and investment becomes seriously distorted. In fact, one who decides to save all of his income will have no appreciable affect on the supply for lonable funds because that supply would be the same if he had chosen to spend all of it. He either deposits all of his income at which point the bank loans it all out (minus reserves), or he spends it all at some department store, at which point that department store deposits it and then their bank loans it all out (minus reserves). One's decision to save will not at all be different from one's decision to spend.
Nearly all economists rely on the market for loanable funds --- in fact, I do not see how the several popular business cycle theories (in particular the Austrian Business Cycle theory) could work without this model. But we must recognize the limitations of this model. Austrians concerned with market processes should immediately note the impossibility of a perfectly equilibrated market in loanable funds. Additionally, the existence of bank credit makes the distinction between savings and investment meaningless which, as a consequence, casts considerable doubt on the usefulness of the market for lonable funds model.
Now economists will respond to this argument by suggesting that firms do not typically hold "balances of bank liabilities at the same rate" as households do. Firms usually, as Fiona Maclachlan explains, enter "directly into the bond market" rather than deposit all of their money in a bank account. In this situation, then perhaps the argument could be made that they are "introducing a new supply of lonable funds". However, Machlachlan, using the liquidity preference theory of interest argues that:
"a great deal of the activity in the bond market has nothing to do with new saving and new investment. The marginal bond seller may not be a firm trying to raise new funds but rather a wealth-holder who wants to sell bonds so that he can invest in something else. Similarly, the marginal buyer may not be someone who has done any new saving but rather a wealth-holder who is cashing in another investment to buy the bond. The price of bonds is determined on the margin but this marginal trade does not appear in the lonable funds diagram" (page 144).
What I take away from this argument is that speculation will in all circumstances act to distort the real forces of savings and investment. Moreover, these speculative acts play a far greater role in determining the interest rate than do acts of saving and investment, whether it be conducted on a micro- or "aggregate level". This also gets back to Maclachlan's earlier chapter in stocks and flows. The debate on stocks vs. flows shows that exchange of existing assets plays a greater role than the production of new assets. So, new savings and borrowing is unimportant when compared to the activity that occurs between existing asset holders (the effects of the latter often overwhelm the effects of the former).
Maclachlan also explicitly attacks Hayek's Ricardo effect, a concept which plays a very important role in his Business Cycle theory. Basically, Maclachlan argues that while increases in consumer demand will lead typically to a fall in investment, decreases in consumer demand will NOT lead to an increase in investment.
 An excellent reconsideration of liquidity preference May 26, 2005
Michael Emmett Brady (Bellflower, California ,United States)
2 out of 2 found this review helpful
Fiona MacLachlan(FM)has written an excellent summary and defense of Keynes's theory of liquidity preference contained in the General Theory(1936;GT).She clearly understands that it is the uncertainty(ambiguity) of the future course of events facing an individual investor that results in his decision to hold more(or less)liquid reserves in his portfolio (that earns little or no return) and not the risk of the future course of events.FM demonstrates that all of Keynes's critics inevitably return to a conceptualization that emphasizes risk(a known probability distribution with a particular and specific mean-variance(standard deviation))either explicitly or implicitly.FM argues convincingly that Tobin's classic exposition of"Liquidity Preference as Behavior toward Risk"is off the mark as far as being a representation of the generality of Keynes's theory of liquidity preference.It in fact is a special case of a much more general theory.Her book is very well written and deserves to be on the bookshelf of anypotential reader who has an interest in finding out what it was that Keynes was arguing in the GT.There are three areas where FM could have improved the technical exposition of Keynes's theory.She unfortunately(see pp.108-109) overlooks the clues in the Keynes-Townshend exchanges of 1937-1938 on the weight of the evidence variable,w,specified by Keynes mathematically in chapter 26 of the A Treatise on Probability(1921)as a measure of the completeness of the evidence upon which a decision maker will attempt to calculate probabilities that will be more or less reliable depending on the value of w.If w =1 and probability preferences are linear, so that there are no nonadditive probabilities(subadditive and/or superadditive),the theory of liquidity preference then simplifies to the analysis of Tobin and others.As w drops farther and farther from 1,the demand for liquidity will become larger and larger as the liquidity schedule shifts to the right,while the shift will reverse itself as w approaches 1.When w=1,the liquidity preference schedule will be a stable downward sloping function of the rate of interest alone.This refutes the claims of Kahn and Shackle who claimed that Keynes made a major error when he specified a clear functional relationship between the demand for money and the rate of interest that had no connection with thrift or productivity.This demonstrates that Kahn and Shackle had absolutely no understanding of the logical,epistemological,philosophical,mathematical or economic foundations of Keynes's theory of liquidity preference during their lifetimes.An alternative foundation for the theory of liquidity preference can also be based on the ambiguity analysis of Ellsberg and his rho variable,which measures the degree of confidence a decision maker has in his data,information,and knowledge.If rho =1,then you obtain results a la Tobin.If rho is less than 1,then you obtain all the results obtained when w<1.This means that Keynes's w and Ellsberg's rho are one to one onto and isomorphic to each other.w can be automatically substituted into Ellsberg's decision theoretic model to obtain results that are identical when you reverse course and substitute rho into Keynes's decision criteria, c,his conventional coefficient of weight and risk.As w or rho approach 0,as happened in post WWI Germany,the demand for liquidity approaches infinity.Secondly, she overlooks the fact that the uncertainty of the GT is an inverse function of w.Finally,she overlooks the fact that Keynes specifically stated ,in additional analysis on p.240 of the GT in chapter 17,a chapter which FM correctly emphasizes,that one must take both risk AND UNCERTAINTY/IGNORANCE into account by discounting marginal efficiency of capital return projections ,not only for time preference(chapter 11 of the GT)but including discounts for risk,uncertainty,and ignorance.
Fascinating study of the interest rate April 17, 2001
3 out of 5 found this review helpful
Author's presentation is lucid and scholarly. Looks at both Austrian, Keynes, and post-Keynesian literature including Davidson. Much discussion of interest rate as inter-temporal allocator of savings. An outstanding work.
veddi gooood February 11, 1999
2 out of 6 found this review helpful
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