liquidity preference
{{Short description|Interest seen as a reward for parting with liquidity}}
{{About|liquidity preference in macroeconomic theory||Liquidity preference (Venture capital)}}
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In macroeconomic theory, liquidity preference is the demand for money, considered as liquidity. The concept was first developed by John Maynard Keynes in his book The General Theory of Employment, Interest and Money (1936) to explain determination of the interest rate by the supply and demand for money.
The demand for money as an asset was theorized to depend on the interest foregone by not holding bonds (here, the term "bonds" can be understood to also represent stocks and other less liquid assets in general, as well as government bonds). Interest rates, he argues, cannot be a reward for saving as such because, if a person hoards his savings in cash, keeping it under his mattress say, he will receive no interest, although he has nevertheless refrained from consuming all his current income. Instead of a reward for saving, interest, in the Keynesian analysis, is a reward for parting with liquidity. According to Keynes, money is the most liquid asset. Liquidity is an attribute to an asset. The more quickly an asset is converted into money the more liquid it is said to be.Macroeconomic Theory, Joydeb sarkhel
Background
{{See also|Robinson Crusoe economy#Money as the origin of interest}}
Keynes acknowledged that the German-Argentine economist Silvio Gesell developed some of the central elements of a precursor theory of interest, decades before he published The General Theory of Employment, Interest and Money in 1936.{{cite book |last=Keynes |first=John Maynard |date=February 1936 |title=The General Theory of Employment, Interest and Money |url=https://userpage.fu-berlin.de/~roehrigw/keynes/engl.htm |location=London |publisher=Macmillan |via=Freie Universität Berlin |chapter=Book 6, Chapter 23: Notes on Mercantilism, The Usury Laws, Stamped Money and Theories Of Under-Consumption |isbn=978-0-230-00476-4 |access-date=30 April 2025 |quote=It is convenient to mention at this point the strange, unduly neglected prophet Silvio Gesell (1862-1930), whose work contains flashes of deep insight and who only just failed to reach down to the essence of the matter. In the post-war years his devotees bombarded me with copies of his works; yet, owing to certain palpable defects in the argument, I entirely failed to discover their merit. As is often the case with imperfectly analysed intuitions, their significance only became apparent after I had reached my own conclusions in my own way.}}
Gesell created a Robinson Crusoe economy thought experiment which showed that interest rates tend to exist in monetary economies while not existing in barter economies.{{Cite web |last=Gesell |first=Silvio |title=Die natürliche Wirtschaftsordnung durch Freiland und Freigeld |trans-title=The Natural Economic Order/Part V/A Story of Robinson Crusoe |date=1916 |location=Bern, Switzerland |translator-last=Pye |translator-first=Philip |via=The Anarchist Library |url=https://theanarchistlibrary.org/library/silvio-gesell-the-natural-economic-order#toc79 |archive-url=https://web.archive.org/web/20250317140424/https://theanarchistlibrary.org/library/silvio-gesell-the-natural-economic-order#toc79 |archive-date=17 March 2025 |access-date=30 April 2025 |df=dmy-all |isbn=9781610330442}}
Gesell identified that interest rates are a purely monetary phenomenon.{{cite AV media |last=Sidman |first=Josh |date=3 April 2024 |title="Silvio Gesell: Beyond Capitalism vs Socialism" Class #6 |url=https://www.youtube.com/watch?v=1GjX4PCcTlU |type=Video |language=English |publisher=Henry George School of Economics |access-date=30 April 2025}}
However, Keynes believed that Gesell's theory only amounted to "half a theory". since Gesell failed to discern the importance of liquidity.
Keynes improved upon Gesell's theory of interest by explicitly recognizing that money has the advantage of liquidity over commodities.
Other scholars like Guido Giacomo Preparata have claimed Keynes essentially stole Gesell's ideas, and then deradicalized them to aid the existing capitalist order.{{cite journal |last=Preparata |first=Guido G. |date=12 December 2002 |title=On the art of innuendo: J. M. Keynes' plagiarism of Silvio Gesell's monetary economics |url=https://www.emerald.com/insight/content/doi/10.1016/s0161-7230(02)20007-3/full/html |journal=Research in Political Economy |volume=20 |publisher=Emerald Group Publishing Limited |pages=217-253 |isbn=978-0-76230-984-9 |doi=10.1016/S0161-7230(02)20007-3 |access-date=25 May 2025}}
Theory
According to Keynes, demand for liquidity is determined by three motives:{{sfn|Dimand|2008}}
- the transactions motive: people prefer to have liquidity to assure basic transactions, for their income is not constantly available. The amount of liquidity demanded is determined by the level of income: the higher the income, the more money demanded for carrying out increased spending.
- the precautionary motive: people prefer to have liquidity in the case of social unexpected problems that need unusual costs. The amount of money demanded for this purpose increases as income increases.
- speculative motive: people retain liquidity to speculate that bond prices will fall. When the interest rate decreases people demand more money to hold until the interest rate increases, which would drive down the price of an existing bond to keep its yield in line with the interest rate. Thus, the lower the interest rate, the more money demanded (and vice versa).
The liquidity-preference relation can be represented graphically as a schedule of the money demanded at each different interest rate. The supply of money together with the liquidity-preference curve in theory interact to determine the interest rate at which the quantity of money demanded equals the quantity of money supplied (see IS/LM model).
According to the Freiwirtschaft school of economics, if the liquidity preference theory of interest rates is correct, then demurrage currency would theoretically have no interest rates, since demurrage money cannot be used as a long-term store of value.{{cite journal |url=https://www.noemamag.com/what-if-money-expired/ |title=What If Money Expired? |last=Baynham |first=Jacob |date=14 November 2023 |website=Noema Magazine |publisher=Berggruen Institute |access-date=26 April 2025}}
Alternatives
A major rival to the liquidity preference theory of interest is the time preference theory, to which liquidity preference was actually a response. Because liquidity is effectively the ease at which assets can be converted into currency, liquidity can be considered a more complex term for the amount of time committed in order to convert an asset. Thus, in some ways, it is extremely similar to time preference.
Criticisms
In Man, Economy, and State (1962), Murray Rothbard argues that the liquidity preference theory of interest suffers from a fallacy of mutual determination. Keynes alleges that the rate of interest is determined by liquidity preference. In practice, however, Keynes treats the rate of interest as determining liquidity preference. Rothbard states "The Keynesians therefore treat the rate of interest, not as they believe they do—as determined by liquidity preference—but rather as some sort of mysterious and unexplained force imposing itself on the other elements of the economic system."{{cite web|author=Murray N. Rothbard |url=https://mises.org/Books/mespm.pdf |title=Man, Economy, and State with Power and Market |date=18 August 2014 |publisher=Ludwig von Mises Institute |page=785}}
Criticism emanates also from post-Keynesian economists, such as circuitist {{ill|Alain Parguez|it}}, professor of economics, University of Besançon, who "reject[s] the keynesian liquidity preference theory ... but only because it lacks sensible empirical foundations in a true monetary economy".Parguez, Alain. "[http://www.panoeconomicus.rs/casopis/devetibroj/money%20creation,%20employment%20and%20economic%20stability.pdf Money Creation, Employment and Economic Stability: The Monetary Theory of Unemployment and Inflation] {{Webarchive|url=https://web.archive.org/web/20160304043150/http://www.panoeconomicus.rs/casopis/devetibroj/money%20creation,%20employment%20and%20economic%20stability.pdf |date=2016-03-04 }}", [http://www.panoeconomicus.rs/ Panoeconomicus], 2008, str. 39-67
See also
Citations
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References
- Gauti B. Eggertsson (2008). [http://www.dictionaryofeconomics.com/sample_article "liquidity trap"], The New Palgrave Dictionary of Economics, 2nd Edition.
- [https://web.archive.org/web/20070316184538/http://william-king.www.drexel.edu/top/prin/txt/money/QT7.html Liquidity Preference Curve]
- {{cite book |url=http://www.dictionaryofeconomics.com/article?id=pde2008_M000370| first1=Robert W. | year=2008 | last1=Dimand| title=The New Palgrave Dictionary of Economics|editor1-first=Steven N.|editor1-last=Durlauf|editor2-first=Lawrence E.|editor2-last=Blume| publisher=Palgrave Macmillan|doi=10.1057/9780230226203.1009|chapter=Macroeconomics, origins and history of | pages=236–244 |isbn=978-0-333-78676-5}}
- {{cite encyclopedia |url=http://www.dictionaryofeconomics.com/article?id=pde2008_L000114| first1=Carlo | year=2008 | last1=Panico| title=The New Palgrave Dictionary of Economics|editor1-first=Steven N.|editor1-last=Durlauf|editor2-first=Lawrence E.|editor2-last=Blume| publisher=Palgrave Macmillan| entry=liquidity preference }}
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