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Liquidity Preference Theory Revisited: To Ditch or to Build on It?

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  • Jorg Bibow
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    Abstract

    This paper revisits Keynes's liquidity preference theory as it evolved from the Treatise on Money to The General Theory and after, with a view of assessing the theory's ongoing relevance and applicability to issues of both monetary theory and policy. Contrary to the neoclassical "special case" interpretation, Keynes considered his liquidity preference theory of interest as a replacement for flawed saving or loanable funds theories of interest emphasizing the real forces of productivity and thrift. His point was that it is money, not saving, which is the necessary prerequisite for economic activity in monetary production economies. Accordingly, turning neoclassical wisdom on its head, it is the terms of finance as determined within the financial system that "rule the roost" to which the real economy must adapt itself. The key practical matter is how deliberate monetary control can be applied to attain acceptable real performance. In this regard, it is argued that Keynes's analysis offers insights into practical issues, such as policy credibility and expectations management, that reach well beyond both heterodox endogenous money approaches and modern Wicksellian orthodoxy, which remains trapped in the illusion of money neutrality.

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    Paper provided by Levy Economics Institute in its series Economics Working Paper Archive with number wp_427.

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    Date of creation: Aug 2005
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    Handle: RePEc:lev:wrkpap:wp_427

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    2. Goodhart, Charles A E, 2000. "Can Central Banking Survive the IT Revolution?," International Finance, Wiley Blackwell, vol. 3(2), pages 189-209, July.
    3. Dow, Sheila C, 1996. "Horizontalism: A Critique," Cambridge Journal of Economics, Oxford University Press, vol. 20(4), pages 497-508, July.
    4. Jörg Bibow, 2004. "Reflections on the current fashion for central bank independence," Cambridge Journal of Economics, Oxford University Press, vol. 28(4), pages 549-576, July.
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    8. Jorg Bibow, 2002. "The Markets versus the ECB, and the EURO's Plunge," Eastern Economic Journal, Eastern Economic Association, vol. 28(1), pages 45-57, Winter.
    9. Wray, L Randall, 1992. "Alternative Theories of the Rate of Interest," Cambridge Journal of Economics, Oxford University Press, vol. 16(1), pages 69-89, March.
    10. Basil J. Moore, 1991. "Money Supply Endogeneity: "Reserve Price Setting" or "Reserve Quantity Setting"?," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 13(3), pages 404-413, April.
    11. Jorg Bibow, 2004. "Assessing the ECB's Performance since the Global Slowdown A Structural Policy Bias Coming Home to Roost?," Macroeconomics 0407026, EconWPA.
    12. Rymes, Thomas K., 1998. "Keynes and Anchorless Banking," Journal of the History of Economic Thought, Cambridge University Press, vol. 20(01), pages 71-82, March.
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    16. Jorg Bibow, 2005. "Germany in crisis: the unification challenge, macroeconomic policy shocks and traditions, and EMU," International Review of Applied Economics, Taylor & Francis Journals, vol. 19(1), pages 29-50.
    17. Bibow, Jorg, 2001. "The Loanable Funds Fallacy: Exercises in the Analysis of Disequilibrium," Cambridge Journal of Economics, Oxford University Press, vol. 25(5), pages 591-616, September.
    18. Jorg Bibow, 2002. "What has Happened to Monetarism? An Investigation into the Keynesian Roots of Milton Friedman's Monetary Thought and Its Apparent Monetarist Legacies," Economics Working Paper Archive wp_347, Levy Economics Institute.
    19. Charles Goodhart, 2000. "Can Central Banking Survive the IT Revolution?," FMG Special Papers sp125, Financial Markets Group.
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    21. Bibow, Jorg, 1995. "Some Reflections on Keynes's 'Finance Motive' for the Demand for Money," Cambridge Journal of Economics, Oxford University Press, vol. 19(5), pages 647-66, October.
    22. Lavoie, Marc, 1996. "Horizontalism, Structuralism, Liquidity Preference and the Principle of Increasing Risk," Scottish Journal of Political Economy, Scottish Economic Society, vol. 43(3), pages 275-300, August.
    23. Arestis, Philip & Howells, Peter, 1996. "Theoretical Reflections on Endogenous Money: The Problem with 'Convenience Lending.'," Cambridge Journal of Economics, Oxford University Press, vol. 20(5), pages 539-51, September.
    24. Bibow, Jorg, 1998. "On Keynesian Theories of Liquidity Preference," The Manchester School of Economic & Social Studies, University of Manchester, vol. 66(2), pages 238-73, March.
    25. A. Asimakopulos, 1986. "Finance, Liquidity, Saving, and Investment," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 9(1), pages 79-90, October.
    26. J. A. Kregel, 1986. "A Note on Finance, Liquidity, Saving, and Investment," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 9(1), pages 91-100, October.
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