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Alternative Theories of the Rate of InterestAuthor(s): J. M. KeynesSource:
The Economic Journal,
Vol. 47, No. 186 (Jun., 1937), pp. 241-252Published by: Blackwell Publishing for the Royal Economic SocietyStable URL:
http://www.jstor.org/stable/2225525
Accessed: 26/01/2009 00:12
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ALTERNATIVE THEORIES OF THE RATE OFINTERESTI
THERE
is, I
think,
a concealeddifference of opinion, whichisof verygreat importance, between myself andagroup of economists whoexpress themselves as agreeing withmeinabandoningthetheorythat therate of interestis(in Prof. Ohlin's words)"determinedbythe conditionthat itequalisesthesupplyofand thedemandforsaving, or,inotherwords, equalises savingand investment."The object of the first section of this article is to bring this differ-ence to a head.The liquidity-preference theory of the rate of interest whichIhave set forth in my General Theory of Employment,InterestandMoney makestherateofinterestto dependon thepresent supplyofmoneyand the demand schedule forapresent claim on moneyin terms of a deferred claim on money. This can be put brieflyby sayingthatthe rateof interestdependson the demandandsupplyofmoney; thoughthismaybemisleading,becauseitobscurestheanswer tothequestion, Demand for moneyintermsofwhat?Thealternativetheory held,Igather, by Prof. Ohlinandhis group of Swedish economists, by Mr. Robertson and Mr.Hicks,andprobably by many others, makesitto depend, putbriefly,on the demandandsupply of credit or, alternatively(meaningthesame thing), of loans,atdifferent rates of interest.Someofthewriters(aswillbeseen from thequotations givenbelow) believethatmy theory is on the whole the same as theirsand mainly amounts to expressing it in a somewhat different way.'Neverthelessthetheoriesare,Ibelieve, radically opposedtooneanother. The following quotations will explain the point atissue.Much thefullestaccountof thistheory has been given by Prof.Ohlin inthe articleprintedabove(p.
221).2
For convenience of
1Prof. Ohlin, as will be seen above (p. 227), indicatesadifference"in oneessential respect," but this is much subsequent to the point in his argumentwhere thedivergence I shall callattention tooccurs-which is, indeed, fromthevery outset.
2
SincethisarticleimmediatelysucceedsProf. Ohlin's, I oughttosay,toavoid misunderstanding, that it is not intended to discuss more than a smallpartofhis arguments, many of which I accept at least in part. In particular,Ihopetoreturn later to a discussion of what the Swedish school conveniently
 
242 THE ECONOMICJOURNAL [JUNE
reference, I will quote what seems to me to be the essential passage;but the reader can easily compare it with the complete context:The rate of interest is simply the price of credit,andistherefore governed by the supply of and demand for credit.The banking system-through its ability to give credit-caninfluence, and to some extent does affect, the interestlevel.Ex-post one finds equality between the total quantityofnew credit duringtheperiod and the sum total of positiveindividual savings. (Of course, a person who uses his ownsavingsis then said togivecreditto himself;thissupplyandthis demand offset one another and exert no influence ontheprice of credit.) Thus, there is a connection betweentherate of interest,which is the price of credit, and the process ofeconomic activity, ofwhichthe flow of savingis apart.To explain how the rates of interest are actuallydeter-mined we need, however,acausal analysis which runs chieflyin ex-ante terms. What governs the demand and supply ofcredit? Two ways of reasoning are possible. One isnetand deals only with new credit, and the other isgrossandincludes the outstanding old credits. The willingness ofcertain individuals during a given period to increase theirholdings of various claims and other kinds of assets minusthewillingness of otherstoreducetheircorresponding holdingsgives the supply curves for the different kinds ofnew creditduringtheperiod. Naturally, the quantitieseach individualiswillingto supply depend on the interestrates.'
Inother
words,theplansareinthe natureofalternativepurchaseandsales plans. Similarly,thetotal supplyof newclaimsminusthe reduction in the outstanding volume of old ones gives thedemand-alsoafunction ofthe rates ofinterest-for thedifferent kinds ofcreditduring the period.Thepricesfixedon themarket for these different claims-and therebytherates of interest-are governed by this supplyand demandinthe usualway.2Beforeanalysingthispassage,itwill beconvenienttogive mytexts from Mr. Hicks and Mr. Robertson. Mr. Hicks, reviewing
call ex-post and ex-ante concepts. I must, however, take thisopportunitytoapologise at once if I have led any reader to suppose that, as Prof. Ohlinseemsto think (p. 234 above), I regard Mr.Hawtreyand Mr. Robertson asclassicaleconomists ! On the contrary, they strayed from the fold soonerthanIdid.Iregard Mr. Hawtrey as my grandparent and Mr. Robertson as my parentinthe paths of errancy, and I have been greatlyinfluencedby them. Imightalso meet Prof. Ohlin's complaint by adopting Wicksell as mygreat-grandparent,if I had known his works in more detail at an earlier stage in my ownthoughtand alsoif Ididnot have thefeeling that, Wicksell was tryingto be"classical."As it is, sofarasI amconcerned,Ifind, looking back,thatitwas Prof.IrvingFisher who wasthegreat-grandparentwhofirst influenced me strongly towardsregarding moneyasa"real"factor.IMy italics.
2
Pp.220 and224-5 above.
of 00

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