Keynes' General Theory of Interest: A Reconsideration (Routledge Foundations of the Market Economy)

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In Keynes' General Theory of Interest Fiona Maclachlan rehabilitates the largely discredited liquidity preference theory of interest, providing an original and rigorously reasoned restatement of the theory. Her provocative book draws on the methodological tenets of the Austrian school and is grounded firmly both in the history of economic thought and in real world economic institutions.

Keynes' General Theory of Interest: A Reconsideration (Routledge Foundations of the Market Economy) Review

Fiona MacLachlan(FM)has written an excellent summary and defense of Keynes's theory of liquidity preference contained in the General Theory(1936;GT).She clearly understands that it is the uncertainty(ambiguity) of the future course of events facing an individual investor that results in his decision to hold more(or less)liquid reserves in his portfolio (that earns little or no return) and not the risk of the future course of events.FM demonstrates that all of Keynes's critics inevitably return to a conceptualization that emphasizes risk(a known probability distribution with a particular and specific mean-variance(standard deviation))either explicitly or implicitly.FM argues convincingly that Tobin's classic exposition of"Liquidity Preference as Behavior toward Risk"is off the mark as far as being a representation of the generality of Keynes's theory of liquidity preference.It in fact is a special case of a much more general theory.Her book is very well written and deserves to be on the bookshelf of anypotential reader who has an interest in finding out what it was that Keynes was arguing in the GT.There are three areas where FM could have improved the technical exposition of Keynes's theory.She unfortunately(see pp.108-109) overlooks the clues in the Keynes-Townshend exchanges of 1937-1938 on the weight of the evidence variable,w,specified by Keynes mathematically in chapter 26 of the A Treatise on Probability(1921)as a measure of the completeness of the evidence upon which a decision maker will attempt to calculate probabilities that will be more or less reliable depending on the value of w.If w =1 and probability preferences are linear, so that there are no nonadditive probabilities(subadditive and/or superadditive),the theory of liquidity preference then simplifies to the analysis of Tobin and others.As w drops farther and farther from 1,the demand for liquidity will become larger and larger as the liquidity schedule shifts to the right,while the shift will reverse itself as w approaches 1.When w=1,the liquidity preference schedule will be a stable downward sloping function of the rate of interest alone.This refutes the claims of Kahn and Shackle who claimed that Keynes made a major error when he specified a clear functional relationship between the demand for money and the rate of interest that had no connection with thrift or productivity.This demonstrates that Kahn and Shackle had absolutely no understanding of the logical,epistemological,philosophical,mathematical or economic foundations of Keynes's theory of liquidity preference during their lifetimes.An alternative foundation for the theory of liquidity preference can also be based on the ambiguity analysis of Ellsberg and his rho variable,which measures the degree of confidence a decision maker has in his data,information,and knowledge.If rho =1,then you obtain results a la Tobin.If rho is less than 1,then you obtain all the results obtained when w<1.This means that Keynes's w and Ellsberg's rho are one to one onto and isomorphic to each other.w can be automatically substituted into Ellsberg's decision theoretic model to obtain results that are identical when you reverse course and substitute rho into Keynes's decision criteria, c,his conventional coefficient of weight and risk.As w or rho approach 0,as happened in post WWI Germany,the demand for liquidity approaches infinity.Secondly, she overlooks the fact that the uncertainty of the GT is an inverse function of w.Finally,she overlooks the fact that Keynes specifically stated ,in additional analysis on p.240 of the GT in chapter 17,a chapter which FM correctly emphasizes,that one must take both risk AND UNCERTAINTY/IGNORANCE into account by discounting marginal efficiency of capital return projections ,not only for time preference(chapter 11 of the GT)but including discounts for risk,uncertainty,and ignorance.

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