¹ 1st ed., 1930. Reprinted by St. Martin's Press for the Royal Economic Society. 1971. The Collected Writings of J.M. Keynes, V. 5 and 6. [All subsequent quotes from Keynes will be to the indicated volume of this set = C.W.]Google Scholar

² Treatise, V. 1. The Pure Theory of Money. C.W., V. 5, containes Keynes' ideas on the theory of the credit cycle.Google Scholar

³ Treatise, V. 2, The Applied Theory of Money C.W., V. 6, contains Keynes' ideas on the long run theory of interest implicit in a description of Gibson's Paradox (GP).Google Scholar

⁴ Lerner, A.P., “Alternative Formulation of the Theory of Interest,” E.J., (48: 190), 06 1938, 211–30 is one of these writings. Lerner finds that Keynes' short run theory of interest is equivalent to Ohlin's (223–25) and that Ohlin's, “the clearest of such modern formulations of interest theory,” (229) is a slightly changed version of the classical theory.Google Scholar

⁵ c.f.: Blaug, M.. Economic Theory in Retrospect, Cambridge. 4th ed., 1985. 641–642. Lerner's definition of the loanable funds equilibrium condition is reproduced here.Google Scholar

⁶ Lerner. Op. Cit., 213–15. The short run nature of the theory is made clear by statements such as: “The M curve shows the increase in the amount of money in the period…” (215). “Hoarding (is) the increase in the amount of money held in the period as each rate of interest…” (219). The variables are “nominal” because changes in money supply and demand are stated in “absolute” terms. Furthermore, the rate of inflation is implicitly assumed to be fixed. Although the interest rate may vary, the rate of inflation is never allowed to vary; e.g., fig. 2, 216. We discuss later the proposition implicit in short run interest determination using this method, that when the nominal interest rate varies and the rate of inflation is constant, the real interest rate varies in the same direction.Google Scholar

⁷ Ibid., 223

⁸ Ibid., 211

⁹ Ibid., 217

¹⁰ Ibid., 221–22.

¹¹ Ibid., 223. Here, Lerner is describing Keynes' money market theory of interest form the General Theory.

¹² See equation 2. In Keynes' Treatise model, we will see that investment is still stressed as the demand for loanable funds, though in a more complicated form than in equation 2. Savings, however, will be almost totally neglected.

¹³ Treatise (1), Op. Cit., chapter 17 is titled: “Changes Due to Monetary Factors.” Chapter 18 is titled: “Changes Due to Investment Factors.” They are both “comparative statics” analyses meant to explain the business cycle. Therefore, they are meant to justify changes in equilibrium income. We will devote most of our attention in the subsequent analysis to chapter 18.

¹⁴ Ibid., chapter 15, “The Industrial Circulation and the Financial Circulation.” 217.

¹⁵ Ibid., chapter 18, 260–61.

¹⁶ “For an increased volume of money may be furnished for the industrial circulation as a result of a decrease in the financial circulation…” Ibid., 256. Presumably, the opposite statement would also hold.

¹⁷ Ibid.

¹⁸ This is a similar (but not identical) technique to introducing a lack of coordination between savings and investment. The lack of coordination between savings and investment in Keynes' General Theory is more in the nature of a lag than the lack of coordination between savings and the supply of loanable funds in Keynes' Treatise. Savings and investment in the General Theory are thought of as simultaneously part of the loanable funds market, even though they are unequal. Eventually, their equality will take place, if disequilibrium output adjustments occur. Savings is not considered as part of the loanable funds market in the Treatise model of interest determination, so eventual credit market adjustments are less certain.

¹⁹ See n. 13.

²⁰ Ibid., chapter 15, “The Industrial Circulation and the Financial Circulation,” section 3, “Factors Determining the Volume of the Fianancial Circulation,” 223.

²¹ Ibid.

²² Ibid., 223–24.

²³ We shall subsequently show that Keynes makes a “bear” security market equivalent to a slump in the credit cycle of the economy. He discusses both simultaneously.

²⁴ Treatise (1)., Op. Cit., 261.Google Scholar

²⁵ Ibid., 259.

²⁶ Treatise (1), chapter 17, describes more implications about variations in the bank rate during the cycle then does chapter 18, which we are emphasizing in the current discussion.

²⁷ See Lerner, Op. Cit., 211, n. 1: “I have put the word ‘classical’ in inverted commas throughout this article because I believe that the theory of interest referred to by that label here and in Mr. Keynes' writings was not clearly held by many economists who have right to that title.” Ricardo should be put in the latter group. It would be interesting to make a list of the group of “classical” economists who do use savings and investment as the primary determinants of the interest rate in the short period.

²⁸ Keynes does not explicitly consider the mechanism for the bank rate to change in Treatise (1), chapter 18. We are considering such a mechanism because we wish to clarify Keynes' short run credit market. It is made up of 2 parts–the new and old securities market–money for the industrial and financial circulations. We also wish to show, considering these two segments of the credit market, how the bank rate may uniformly change throughout the economy.

²⁹ Treatise (1), Op. Cit., chapter 18. See especially 256 (for a boom) and 260–61 on how the rate of inflation becomes negative during a slump.Google Scholar

³⁰ C.W., V. 6. See Book 6 (“The Rate of Investment”), chapter 30, “Historical Illustrations,” section 8, “The Gibson Paradox,” 177–186.Google Scholar

³¹ Ibid., 180

³² Ibid., 177–78.

³³ Ibid., 177.

³⁴ Ibid.See n. 2. The positive relation between the price level and the nominal interest rate may be regarded a “paradox,” in the sense that the price level is generally regarded by economists as directly related to the money supply and the nominal interest rate as inversely related to the money supply. So, no matter how the money supply is changing, the price level and the nominal interest rate should be inversely related. Yet, Keynes does not discuss the money supply growth rate in Treatise (2), chapter 30, section 8. There must be some other reason why Keynes regards this relation as a paradox. See also p. 380 in Friedman, M., “Factors Affecting the Level of Interest Rates.” Proceedings, 1968 Conference on Savings & Residential Financing, ChicagoGoogle Scholar, U.S. Sav. and Loan League, 1969. Reprinted in: Havrilesky, J. and Boorman, J., Current Issues in Monetary Theory & Policy, AHM Publishers, 2nd ed. 1980.Google Scholar

³⁵ Ibid., table 178, last column heading.

³⁶ The reader should remember, from the discussion in the previous section, that Keynes' description of a “theory” for short run interest movements during the cycle was not well developed, it may be at best described as: tentative.

³⁷ See: M. Gootzeit, “Wicksell's Short Run Theory of Inflation,” unpublished 1986, for a description of the role of the 2-rate differential in Wicksell's theory of inflation. If the 2-rate differential is defined as: (i_natural-i_market), where i is the nominal interest rate, we will show for Keynes, that if in equilibrium the 2-rate differential is zero and if it declines because i_n falls faster than i_mkt, the price level also declines. For Wicksell, if the differential incrreases because i_mkt falls in relation to i_n, the price level also increase. We have here a similarity between Keynes' and Wicksell's theories of inflation; the price level moves in the same direction as the 2-rate differential

³⁸ Treatise (2), Op. Cit., 182–183.Google Scholar

³⁹ Ibid., 182.