The Theory of Interest

This chapter explores Oskar Lange’s theory of interest, focusing particularly on his seminal 1938 article, “The Rate of Interest and the Optimum Propensity to Consume”. Drawing inspiration from Keynes’ General Theory, Lange aimed to reconcile liquidity preference, the marginal efficiency of investment and the propensity to consume within a cohesive framework. His model, based on four equations, generalises both Keynesian and classical theories, viewing them as specific instances of a more comprehensive theory. Lange’s analysis addresses the issue of underconsumption in capitalist economies, arguing that an optimal propensity to consume maximises investment. He suggests that saving beyond this optimal level can stifle economic activity. Unlike Keynes, Lange emphasises the interconnectedness of interest rates, consumption and investment, challenging traditional assumptions about automatic market adjustments. His approach combines Walrasian equilibrium concepts with Keynesian insights, while diverging from the contemporaneous neoclassical synthesis (the well-known IS-LM model) proposed by Hicks by focusing on sequential adjustment processes and the potential for disequilibrium. Ultimately, Lange’s theory contests the classical view of economic optimism, aligning more closely with Keynesian concerns about stagnation and offering a distinct synthesis of economic thought. His work highlights the institutional limitations of capitalism and underscores the necessity for deliberate policy interventions, reflecting his broader socialist inclinations.