Edited by Robert W. Dimand and Harald Hagemann
Chapter 40: Liquidity preference
Keynes is credited with introducing the word ‘liquidity’ to economic discourse. Liquidity preference refers to his new theory of the rate of interest, which is determined by the extent to which asset holders are willing to give up liquidity in exchange for a higher return, in conjunction with the amounts of liquid and illiquid assets that there are. Always a gambler, Keynes added the speculative motive to well-known reasons to prefer liquidity. This involved expectations of future interest rates, as rate movements cause changes in asset valuations. Since expectations of the future are difficult to fit into traditional static models, his theory met resistance, and not only from those wedded to traditional loanable funds theory. His theory was modified as a result and now has largely dropped out of sight, despite its explanatory power in the financial crash.
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