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

Jörg Bibow

Economics Working Paper Archive from Levy Economics Institute

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.

Date: 2005-08
New Economics Papers: this item is included in nep-hpe, nep-mac and nep-mon
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Citations: View citations in EconPapers (2)

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Working Paper: Liquidity Preference Theory Revisited—To Ditch or to Build on It? (2005)
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