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

  • Jorg Bibow
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    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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    File URL: http://www.levyinstitute.org/pubs/wp_427.pdf
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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. 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.
    3. Runde, Jochen, 1994. "Keynesian Uncertainty and Liquidity Preference," Cambridge Journal of Economics, Oxford University Press, vol. 18(2), pages 129-44, April.
    4. 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.
    5. 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.
    6. 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.
    7. Dow, Sheila C, 1996. "Horizontalism: A Critique," Cambridge Journal of Economics, Oxford University Press, vol. 20(4), pages 497-508, July.
    8. 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.
    9. Jorg Bibow, 2004. "Assessing the ECB's Performance since the Global Slowdown A Structural Policy Bias Coming Home to Roost?," Macroeconomics 0407026, EconWPA.
    10. 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.
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    12. Lavoie, M, 1995. "Horizontalism, Structuralism, Liquidity Preference and the Principle of Increasing Risk," Working Papers 9513e, University of Ottawa, Department of Economics.
    13. Trevithick, J A, 1994. "The Monetary Prerequisites for the Multiplier: An Adumbration of the Crowding-Out Hypothesis," Cambridge Journal of Economics, Oxford University Press, vol. 18(1), pages 77-90, February.
    14. 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.
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    16. Milton Friedman, 2002. "Comment on Gaspar and Issing," Australian Economic Papers, Wiley Blackwell, vol. 41(4), pages 366-368, December.
    17. 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.
    18. Cottrell, Allin, 1994. "Post-Keynesian Monetary Economics," Cambridge Journal of Economics, Oxford University Press, vol. 18(6), pages 587-605, December.
    19. Goodhart, Charles A E, 2000. "Can Central Banking Survive the IT Revolution?," International Finance, Wiley Blackwell, vol. 3(2), pages 189-209, July.
    20. Greg Hannsgen, 2004. "Gibson's Paradox, Monetary Policy, and the Emergence of Cycles," Economics Working Paper Archive wp_410, Levy Economics Institute.
    21. 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.
    22. 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.
    23. Charles Goodhart, 2000. "Can Central Banking Survive the IT Revolution?," FMG Special Papers sp125, Financial Markets Group.
    24. Andrea Terzi, 2004. "The independence of finance from saving: A flow-of-funds interpretation," Macroeconomics 0405017, EconWPA.
    25. 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.
    26. Gary A. Dymski, 1988. "A Keynesian Theory of Bank Behavior," Journal of Post Keynesian Economics, M.E. Sharpe, Inc., vol. 10(4), pages 499-526, July.
    27. Bruce Greenwald & Joseph E. Stiglitz, 1993. "New and Old Keynesians," Journal of Economic Perspectives, American Economic Association, vol. 7(1), pages 23-44, Winter.
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