Writers agree that the two theories, “loanable funds” and “liquidity preference”, are merely different ways of saying the same thing - but they reach this conclusion by diverse processes in varying ways. Yet in the end the view of the controversy as a “sham dispute” will not be challenged, and it will be argued that revised terms of settlement, less ambiguous than the old, may be subscribed to by the adherents of “liquidity preference” and “loanable funds” alike. J. R. Hicks, in his chapter on the determination of the rate of interest refers to a “sham dispute within the ranks of those who adhere to the monetary approach. Is the rate of interest determined by the supply and demand for loanable funds (that is to say, by borrowing and lending); or is it determined by the supply and demand for money itself? This last view is put forward by Mr.Keynes in his General Theory.
Trevor W. Swan, 1941 “Some Notes on the Interest Controversy”, The Economic Record, 17, (December), 153–165: 107–118.
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Notes
- 1.
Value and Capital, p. 153.
- 2.
Ohlin: “Some Notes on the Stockholm Theory of Saving and Investment” (E.J., March, 1937, June, 1937). Keynes: “Alternative Theories of the Rate of Interest” (E.J., June, 1937). Ohlin, Robertson, Hawtrey: “Rejoinders” (E.J., September, 1937). Keynes: “The 'Ex Ante' Theory and the Rate of Interest” (E.J., December, 1937). Robertson. Keynes: “Mr. Keynes and 'Finance'” (E.J., June, 1938).
- 3.
(a) Hicks: E.J., June, 1936, p. 246, “The choice between them is purely a question of convenience”.
(b) Robertson: Essays in Monetary Theory, p. 9, “Essentially they are two different ways of saying the same thing”.
(c) Lerner: E.J., June, 1938, p. 227. “Mr. Robertson is right when he says that his apparatus and ·Mr. Keynes' are 'but alternative pieces of machinery'”.
(d) Kalecki: Essays in the Theory of Economic Fluctuations. No formal statement can be quoted, but in the essays “Money and Real Wages” and “The Long-term Rate of Interest” the theories are used interchangeably.
(e) Haberler: Prosperity and Depression, Haberler's statements (pp, 208, 212) are qualified by the adverbs “almost”and “frequently”, but his general treatment, and in particular hie numerous translations from "loanable funds" to “liquidity-preference” language, leave the reader In no doubt that he would agree with the views quoted (see especially p. 196, footnote 3, pp. 211–218, and pp. 296, 302, 379). Page references are to the second edition. Haberler's attitude is discussed in more detail below.
(f) For other writes: Hawtrey's position is (as usual where issues of formal theory are concerned) strictly individual and obscure. E. S. Shaw of Stanford (Journal of Political Economy, December 1938) is in full agreement with Robertson. Mrs. Robinson, on the other hand, maintains in her last published comment (E.J., June, 1988) an uncompromising attitude: “The Issue involved is a substantial one, not a question of terminology”.
- 4.
See especially E.J., September, 1937, p. 426.
- 5.
When the controversy ended in June, 1938, Keynes was still belaboring Robertson, but the argument had been side-tracked from the main issue by confusion over “finance”: the comprehensive article which Keynes promised (with the stated prospect of convincing Ohlin) in December, 1937 (E.J., p. 663), has not yet appeared. There is, however, a footnote to the penultimate sentence of Keynes' “last word” in June, 1938 (p. 322), which makes it almost certain that Keynes had accepted Lerner's reconciliation. For he refers with approval to a major point of Lerner's article, and takes him gently to task over a very minor one.
More recently (in articles in The Times July, 1939) Keynes has used a theory of interest which looks suspiciously like “loanable funds” (see Robertson: Essays in Monetary Theory, p. 14). It may therefore be assumed that Keynes had withdrawn at least his original contention that the two theories are “radically opposed”—a contention which was obviously based in the first place on a complete misunderstanding of Ohlin's concepts. If this view is accepted, it suggests that the continuance of the squabble with Robertson was attributable to minor Robertsonian issues—or perhaps to force of habit.
- 6.
T. de Scitovszky (Economica, August, 1940) gives a reference to an article by P. Bauer, “Die allgemeine Theorie von Keynes und ihre Kritiker” (Zeitachrift fur Nationskonomie, vol. 9, p, 99), which suggests that a third “proof” may conceivably have appeared In German. Reference may also be made to an article on this subject by W. Fellner and H. M. Somers in the Review of Economic Statistics, vol. xxii, no. 1.
- 7.
This is not a criticism of Hicks. Only the generality of his argument is in question, not its validity. But for a criticism on the score of validity (on mathematical grounds) see Morgenstern: Journal of Political Economy, June, 1941, p. 389.
- 8.
It is necessary to add the pre-existing quantity of money to both sides in order to state the equation of supply and demand in terms of the total amount of liquidity (as Keynes does) rather than the increase in supply and demand during the given period.
- 9.
This was stated very emphatically by Ohlin no less than six times in the Economic Journal, for March, June and September, 1937. In addition in September, 1937 (pp. 423–424), Ohlin pointed out that Keynes was guilty (in June, 1937) of exactly the same confusion between ex ante and ex post concepts which Lerner reproduced in June, 1938.
- 10.
Alternative Formulations of the Theory of Interest, E.J., June, 1938. pp. 213–215.
- 11.
The fullest accounts are to be found In E.J., 1937, pp. 423 et seq. (Ohlin), and Essays in Monetary Theory, pp. 2–5 (Robertson). The formal difference between Ohlin's and Robertson’s definitions of saving and Investment does not affect the situation at this stage. (On this point see Haberler, op. cit., pp. 188–191. Haberler's comparison is perhaps too favourable to Robertson.) The reader should, however, be given preliminary warning that Haberler's approval of the diagram la subject to an implied reservation concerning the meaning of “boarding” (the L curve). (See below, pp. 159–160.)
- 12.
The letters P, and K have been added to Lerner's original diagram, in which these points are not lettered.
- 13.
See references given in footnote (3) p. 153 above. His general statements are more cautious. For example, on p. 208 he writes: “Their disagreement is frequently due to their failure to realise the fact that they start from different assumptions, rather than to the fact that they arrive at different conclusions under the same set of assumptions”. Or again, on p. 212: “Apart from terminological differences this theory (‘liquidity-preference') and the loanable-fund theory would seem to be almost identical”. Thus he qualifies his formal statements of the equivalence of the theories, but gives no hint of the circumstances in which this qualification might be necessary. Is this the result of a conscience vaguely uneasy?
- 14.
The denial is implicit in Haberler's analysis—he draws no specific attention to the point P, (on our diagram) at which the curves intersect. Haberler's argument takes the form of a reply to Lerner's criticism that at the “loanable funds” interest rate OD the L curve exceeds the M curve by an amount EF, which indicates, according to Lerner, that “the amount of money hoarded is not equal to the increase in the amount of money”. (As Robertson might say, there is evidently more money somewhere than there is anywhere.) This paradox is merely another way of stating the apparent conflict between the “loanable funds” and “liquidity-preference” theories—the rate of interest which satisfies one does not satisfy the other. Haberler promises a reply on p. 187 (footnote) and fulfills his promise on pp. 200–201.
- 15.
Haberler himself makes no attempt to remedy this deficiency in analytical technique. Having shown, by his own reckoning, that “loanable funds” equilibrium does not imply disequilibrium in the “liquidity market,”, he stops short of the positive demonstration that “loanable funds” equilibrium necessarily implies equilibrium in the “liquidity market”. When later (p. 205) Haberler begins a comparison of the two theories, he is obliged by his lack of theoretical apparatus to work out the consequences of various specific situations in terms of each theory. In each case the results are shown to agree, but closer examination reveals that the analysis establishes only the direction of the movement in the rate of interest, and has nothing to say about its magnitude. One might well suspect the validity of an interpretation which reduces a writer of Haberler's quality to this rough and laborious empiricism.
- 16.
The sale of assets will be counted either as borrowing or disinvestment, and will therefore not affect the position as stated.
- 17.
Ohlin does not use the word “hoarding”; it is put into his mouth (in parenthesis) by Haberler (p. 184) when he quotes Ohlin's statement at some length. Lerner, when he labelled the L curve “hoarding” (interpreting it aa representing the accumulation of money in general) was merely giving a name to Ohlin's “increase in the quantity of cash”. This process can scarcely be regarded (cf., Haberler, p, 187) as an “imputation to other writers of his own definition of... hoarding anddishoarding”.
- 18.
When Haberler defines “hoarding” with respect to “the accumulation of idle balances”, he makes it clear that “idle balances” can be defined strictly only in terms of changes in the velocity of circulation of money (In some sense). In order to do Haberler full justice, it would perhaps be necessary to follow up this qualification. But it is hard to see how the following-up might be achieved, in view of the obscurity of Haberler's definition of V and the Inherent difficulty of handling velocity concepts ( necessarily ex post) in an ex ante analysis.
- 19.
This can perhaps be seen more clearly in an algebraic comparison of equilibrium according to each theory. According to the “loanable funds” theory, in equilibrium
$$S\left( i \right){ + }M\left( i \right){ = }I\left( i \right){ + }L\left( i \right)$$(1)all variables being shown as functions of the rate of interest i
According to the original “liquidity preference” theory, in equilibrium
$$M\left( i \right){ = }L\left( i \right)$$(2)This is identical with (1) only if \(S\left( i \right){ = }I\left( i \right)\) According to the modified “liquidity preference” theory, and denoting “imaginary” money by \(M^{I}\), in equilibrium \(M\left( i \right){ + }M^{I} \left( i \right){ = }L\left( i \right)\) But (see text) \(M^{I} \left( i \right){ = }S\left( i \right){ - }I\left( i \right)\):
$$M\left( i \right){ + }S\left( i \right){ - }I\left( i \right){ = }L\left( i \right)$$(3) - 20.
This was first recognized by Hansen, reviewing the General Theory (Journal of Political Economy, 1936). It brought out very clearly in the diagrammatic expositions of the Keynesian system by Hicks (Econometrica, 1937) and Lange (Economica, 1938).
- 21.
The nature of this simplification is shown clearly by Lange (Economica, 1938, p. 23).
- 22.
It was for this reason that Hansen (op. cit) described the method of the “General Theory” as more “classical”even than Marshall (though the basic technique is strictly Marshallian). Hicks has shown, however (Value and Capital), that the Marshallian “equilibrium” technique can be harnessed to a modified form of “period” analysis. The temporary market equilibrium of the “period” analysis (as shown in the “loanable funds” diagram) should of course be distinguished sharply from “equilibrium” in the more “ambitious” sense in which it is used above.
- 23.
This is not the only consideration which will affect the relative convenience of the two approaches. Hicks, for example, suggested (E.J., June, 1936) that “loanable funds” would be more convenient for problems involving different types of securities and interest rates. Nevertheless, in Value and Capital Hicks' analysis of long and short term rates is an extension of “liquidity-preference” theory to take account of the varying degrees in which securities of different types may satisfy the demand for liquidity. A similar approach is followed by Scitovszky (Economica, August 1940).
- 24.
The analysis appropriate to “liquidity-preference” if the complication of “imaginary money” is introduced can be illustrated by a comparison of the views of Keynes and Robertson as to the mechanism by which increased thrift (a fall in the Propensity to Consume) leads to a fall in the rate of interest (cf. Robertson: Essays in Monetary Theory, pp. 18–20). Both argue that the rate of interest will fall but Keynes insists that the thrift will operate on the rate of interest only indirectly by depressing the level of incomes and so releasing liquidity absorbed in transactionsbalances, while Robertson argues that it “lowers the rate of interest quite directly through swelling the money stream of demand for securities”. If no account is taken of "imaginary money", Keynes is forced by his theory to insist on the indirect mechanism, but the increased thrift (decreased consumption spending) will mean that some incomes will be unexpectedly lower and/or stocks of goods will be unexpectedly higher—ex ante asavings will therefore exceed ex post savings, and ex post investment will exceed ex ante investment. The corresponding excess of ex ante savings over ex ante investment implies a sudden increase in the supply of liquidity in the form of “imaginary money”—in other words, the “savers” know themselves to be more liquid, whereas those who suffer by reason of the reduced consumption spending are temporarily unaware of the reduction in their liquidity. The increased thrift may therefore be said to operate directly by increasing the supply of liquidity in the form of “imaginary money”.
- 25.
Robertson: Essays in Monetary Theory, p. 24.
- 26.
E.J., June, 1937.
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Swan, P.L. (2022). T. W. Swan: “Some Notes on the Interest Controversy”. In: Trevor Winchester Swan, Volume I. Palgrave Studies in the History of Economic Thought. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-031-13737-2_5
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