The Demand and Supply for Money [M=L(r) ] is not the Demand and Supply for Liquidity[M=M1plus M2=L1(Y) plus L2(r) {=L}

Abstract

A major confusion among economists ,who have been writing on the General Theory since 1936,is to confuse the Demand and Supply for Money [M=L(r) ] with the Demand and Supply for Liquidity[M=M1plus M2=L1(Y) plus L2(r) {=L}.


Chapter 13 of the General Theory concentrates exclusively on the second of the two constituents which, together, determine the equilibrium rate of interest. The first constituent, the mec and investment multiplier, determines the IS equation(curve). Keynes dealt with this in chapters 8-12 of the General Theory. Keynes made it very clear that in chapter 13 he was going to deal exclusively with the second constituent, liquidity preference ,which had been ignored by classical economists. Chapter 15 puts both of the constituents together .In Chapter 14 of the General Theory , Keynes demonstrated on pp.179-182 that the neoclassical theory of the rate of interest generated a single downward sloping curve in (Y,r ) space.Neoclassical theory had NO Liquidity Preference Function curve or what Hicks called LL and Hanson called LM.

The belief that Keynes’s theory of the rate of interest is denoted by

M=L(r),

as argued by Hawtrey, Viner, Robertson, Robinson, and Ahiakpor, is false. Keynes’s theory of the rate of interest is given by three mathematical, simultaneous equations presented on pp.298-299 of the GT.The missing equation needed by the classical school is


M = M1 plus M2 = L1( Y) plus L2(r)[=L;author’s insert].


The equation M=L(r) is not the equation Harrod was talking about in his August 30th, 1935 letter to Keynes,a letter that Akiakpor had to have read in 1999 in preparation for his response to O’Donnell(1999).

It is impossible to graph M=L(r) in (Y,r) space


Only M = M1 plus M2 = L1( Y) plus L2(r)[=L;author’s insert] can be graphed in (Y,r) space.

Finally,Keynes incorporated the IS function implicitly into the Liquidity Preference Function by using L 1( Y).That allowed Keynes to talk about the demand and supply for liquidity,as opposed to the demand and supply for money.Keynes’s responses to Joan Robinson in late August –November,1936 concentrated on her complete misunderstanding of the theory of liquidity preference .It shows that Joan Robinson interpreted Keynes’s discussion of the demand and supply for liquidity as being the same thing as the demand and supply for money.

The demand and supply for money is not the same thing as the demand and supply for liquidity.