From Our Guest blogger BF
To recap a bit. Keynes’ theory of liquidity preference is actually a theory of individual portfolio allocation, where savers (whose total level of saving is primarily determined by their income) make decisions about how to distribute their savings across financial assets of varying degrees of liquidity, with money being the most liquid of those assets. We said earlier that JMK saw savers as having a powerful tendency to want to stay liquid: the interest rate is what induces them to give up some liquidity and put part of their savings into less liquid assets. As JMK puts it, the interest rate is the reward not for saving but for giving up liquidity.
A recent editor, Rupert Pennant-Rea, once described The Economist as “a Friday viewspaper, where the readers, with higher than average incomes, better than average minds but with less than average time, can test their opinions against ours. We try to tell the world about the world, to persuade the expert and reach the amateur, with an injection of opinion and argument.” Taken fom The Economist
In my introductory microeconomics class, I require students to write a book review in the style of The Economist. The Economist book reviews are so good that in many ways, once you have read the review you really don’t need to read the book–unless for pleasure of course! These reviews provide an excellent basis on which to decide if a particular book is worth your time. With respect to my class, I am very interested in reading the assignment because the book reviewed is Cocktail Party Economics. (Both The Economist and Cocktail Party Economics are published by Pearson.) Here is my promise to the class–I won’t read the names of the authors so my students can truly write in the spirit of The Economist (authors are anonymous). Opine away!
Blogging the General Theory: Guest blogger BF
OK, Liquidity Preference. The first thing to remember here is that while JMK acknowledges that the rate of interest does influence the rate of savings, he reckons that the primary determinant of savings is income. You’ll hear people complaining that Keynes’ theory of savings and consumption isn’t based on any kind of optimizing behavior but we’ve already seen that that criticism is wrong-headed – JMK’s saver was an intertemporal utility maximizer in all but the formal math. But there’s nothing inconsistent with that in the claim that fluctuations in income are the key factors behind fluctuations in savings in the short run. If you’re on an optimal lifetime asset accumulation path – accumulating savings to live off in retirement, perhaps – fluctuations in income are going to lead to adjustments in savings, especially if you haven’t been hit by any major shocks to your accumulated wealth.