Criticism of Keynes' Liquidity Theory of Interest
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Criticism of Keynes' Liquidity Theory of Interest

Criticism of KeynesÂ’ Liquidity Theory of interest KeynesÂ’ Theory too has come under considerable criticism: Firstly, it has been pointed out that rate of interest is not purely monetary phenomenon. Real forces like productivity of capital and thriftiness also play an important role in the determination of the rate of interest. (ii) Keynes makes the rate of interest independent of the demand for investment funds.

Criticism of Keynes’ Liquidity Theory of interest

Keynes’ Theory too has come under considerable criticism:

Firstly, it has been pointed out that rate of interest is not purely monetary phenomenon. Real forces like productivity of capital and thriftiness also play an important role in the determination of the rate of interest.

(ii) Keynes makes the rate of interest independent of the demand for investment funds. In fact, it is not so independent. The cash supplies of the business men are principally influenced by their requirement for savings for capital investment. The demand for capital investment depends upon the marginal revenue productivity of capital. Therefore, the rate of interest is not determined independently of the marginal productivity of capital or marginal efficiency of capital, as Keynes calls it.

(iii) Liquidity preference is not the only factor governing the rate of interest. There are several other factors which influence the rate of interest by affecting the demand for and supply of investible funds.

(iv) This theory does not explain the existence of different rates of interest prevailing in the market at the same time.

(v) Keynes ignores saving or waiting as a source or means of investible funds. To part with liquidity without there being any saving is meaningless.

(vi) The Keynesian theory explains interest in the short run only. It gives no clue to the rates of interest in the long run.

(vii) Finally, exactly the same criticism applies to Keynesian theory itself on the basis of which Keynes rejected the classical and loanable funds theories. Keynes's theory of interest, like the classical and loanable funds theories, is indeterminate. According to Keynes, rate of interest is determined by the speculative demand for money and the supply of money available for satisfying speculative demand. Given the total money supply, we cannot know how much money will be available to satisfy the speculative demand for money unless we know how much the transactions demand for money is. And we cannot know the transactions demand for money unless we first know the level of income. Thus, the Keynesian theory, like the classical, is indeterminate.

Conclusion

The various theories of the rate of interest put forward from time to time suffer from various drawbacks and are indeterminate. Modern economists like Profs Hicks and Hansen have made a synthesis between these various theories and have given an adequate and determinate theory of interest. They are of the opinion that the classical and loanable funds theories amount to the same thing. The difference between these two theories, i.e., classical and loanable funds, lies only in the meaning of savings. "The Pigovian supply schedule of savings amounts to the same thing as the Robertsonian or Swedish supply schedule of loanable funds."

 

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