hansen 1951

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Classical, Loanable-Fund, and Keynesian Interest TheoriesAuthor(s): Alvin H. HansenSource: The Quarterly Journal of Economics, Vol. 65, No. 3 (Aug., 1951), pp. 429-432Published by: Oxford University PressStable URL: http://www.jstor.org/stable/1882223 .

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8/17/2019 Hansen 1951

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CLASSICAL,

LOANABLE-FUND,

AND KEYNESIAN INTEREST THEORIES

By

ALVIN

H. HANSEN

Keynes

attacked

the classical theory f interest n the

ground

that it is

indeterminate.According

o

classical

theorythe rate is

determined

y the intersection f

the investment

emand-schedule

and thesaving-schedule

schedulesdisclosing

herelation f nvest-

ment and

saving

to the

rate

of interest. No solution,

however, s

possiblebecause the positionof the saving-schedulewill vary with

the

level of real income.

As income

rises,

the schedule will

shift o

the

right.

Thus we cannotknow what the rate

of interestwill

be

unless

we

already

know

the

income evel. And we cannot know the

income evel without

already

knowing he rate of interest,

ince a

lower

nterest ate

willmean a largervolume

of investment,

nd so,

via

the

multiplier,

higher

evel of real ncome.The classicalanalysis,

therefore

ffers

o

solution.

Now exactly he same criticismppliesto the Keynesiantheory.

According

o the Keynesian

theory he rate of

nterest s

determined

by the ntersection f

the supply-schedule

f

money perhaps

nterest

inelastic,

f

rigorously

ixed by

the monetaryauthority)

and the

demand-schedule

ormoney the

iquidity-preference

chedule).

This

analysis

also

is

indeterminate

ecause the

liquidity-preference

ched-

ule

will shift

p

or down with

changes

n

the income

evel. Here

we

are

concerned

with the total

liquidity-preference

chedule

ncluding

both the transactions demandand the asset demandformoney.

If

we separate

the total demand schedule

for

money

into

its

two

component

arts,

we could

perhaps

argue

that the

pure

liquidity-

preference

chedule

is independentof the

level of income.'

But

this does

not

help

matters,

ince

we cannot

know,given

the

total

money upply,

how much

money

will

be available

to

hold

as an asset

unlesswe

first

nowthe evel of

ncome. Thus

the

Keynesian

theory,

like the classical,

s

indeterminate.

n the Keynesian

case the money

supplyand demand-schedulesannotgivethe rateof nterest nless

we

already

know the

income evel;

in

the classical

case

the

demand

and

supply

schedulesfor aving

offer

o

solutionuntil

the

income

s

known.

Keynes' criticism f the

classical theory

pplies equally

to

his

own

theory.

1.

In fact since expectations are

influenced by

the

level

of income

this

is

not a permissible assumption.

The

liquidity preference case

is therefore ven

weaker

than

here

indicated.

429


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430

QUARTERLY JOURNAL

OF ECONOMICS

Precisely

he same s trueof

the oanable-fundheory.According

to the loanable-fund

nalysis, the rate of interest

s determined

y

the intersectionf the demand-schedule or oanable fundswith the

supply-schedule.

Now the supply-schedule

f loanable funds is

compounded f

saving in the Robertsonian

ense) plus net additions

to loanable funds from new

money and the

dishoarding of

idle

balances. But since the savings

portion of the

schedule varies

with he evel

of disposable income,2t follows hat

the total supply-

schedule of oanable

funds lso

varies with ncome.

Thus this theory

is also indeterminate.

In the loanable-fund heory,the relevant supply-schedules

conceivedof

n terms f oanable

funds i.e., voluntary

aving plus

new money).

In the neo-classical

theory of Pigou, however, the

relevant upply-schedules conceived

n terms f aving

out ofcurrent

income. Saving

is defined s

the excess of total income received

over income

received for services n providing

for consumption. '

Again, in the

same vein, aggregatemoney saving

is defined

s

the excess of

money

income over expenditures n consumption

goods. 4 Here income, consumption, nd saving,all apply to the

same

period. Money savings are

that part of current

ncomewhich

is not consumed. Now current

ncome is derived

from current

expenditures.

Whether r not

current ncome s fed n part from

he

injection f newmoney r from

he activationof dle

balances, makes

no difference

hatever rom he

standpoint f the

Pigouvian or neo-

classical definition.5

ncome is income whether

t springs

rom

he

spending of

funds borrowed frombanks or from

the spending

of

prior ncome;and saving from uch income s saving even though

bank credit

played

a

role

n

the process

of

ncome

creation.6

Accord-

ingly,

n

Pigouvianor neo-classical

heory, saving

is

in

effect

he

same

thing

s

loanable

funds.

In

Robertsonian

anguage,however,

loanable funds consist of voluntary

saving

(i.e., saving

out

of

disposable

income) plus borrowed

bank fundsand

activated

idle

balances.

In

Pigouvian anguage, aving out

of current

ncome

may

well exceed

voluntary or Robertsonian) aving

n so far

s

current

income s increasedby bank loans or the injectionof idle balances.

2. Disposable income

is here used in the Robertsonian sense,

i.e.,

yesterday's income.

3. See A. C. Pigou, Employment nd Equilibrium, p. 30.

4. Ibid, p. 31.

5. It is important to be clear about the implications

of

these

definitions

when

people or governments borrow

from the banks. Everybody

agrees that

money so borrowedonly becomes

income when t is paid out, for ervices

rendered,

to factors of production (ibid,

p. 30).

6.

Ibid, p. 30.



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INTEREST

THEORIES

431

Thus the

Pigouviansupply-schedule

f savings

amounts

to the same

thing as

the Robertsonian

or Swedish

supply-schedule

f loanable

funds. It is therefore ot necessary o distinguish urther etween

them,

nd hereafter

shall refer nly

to

the neo-classical7

heory

n

theone side,

and

theKeynesian

on

the other.

The neo-classical

formulation

nd the

Keynesian

formulation,

takentogether,

o supply

us with

an adequate

theory f the

rate

of

interest.

From

the neo-classical

formulation

we get

a family

of

saving-schedules

t various

income

evels. These

together

with the

investment-demand

chedule8

give

us the Hicksian

IS curve.

In

otherwords,the neoclassical formulationells us what the various

levels

of ncome

will be

(given

the

investment-demand

cheduleand

family f

saving-schedules)

t different

ates of

interest.

From

the

Keynesianformulation

we get

a family

of liquidity

preference

chedules

at various

income evels.

These together

with

the

supplyof

money

fixedby the

monetary

uthority, ive

us

the

Hicksian

L

curve (which

prefer o

call the

LM

curve ).9

The

LM curve

tells us what

the

various

rates of

interest

will be (given

thequantityofmoney nd thefamily f iquidity-preferenceurves)

at differentevels of

ncome. But the

iquidity

chedule

lone

cannot

tell

us

what

the

rate of interest

will be.

The IS curve

and the

LM curve

are

functions elating

he

two

variables: (1)

incomeand

(2)

the rateinterest.

Income

and the

rate

of interest

re therefore

etermined

ogether

t the

point

of

intersection

f these two

curves

or

schedules.

At this

point

income

and the rate of interest

tand

in

a relation

o

each other

uch

that:

(1) investmentnd saving re n equilibriumi.e.,actualsavingequals

desired aving)

and (2) the

demand

formoney

s

in

equilibrium

with

the

supply

of money

i.e., the desired

amountof

money s

equal

to

the

actual

supply

of

money).

Thus

a determinate

heory

f nterest

s based

on: (1) the

nvest-

ment demand function, 2)

the saving-function

or

conversely

he

7. The classical

theory

may be said to

coincide

with the

neo-classical

or

Pigouvian theory

n

the special case

in which

no new

money is- eing created

by

the banking systemand in which idle balances are not being dishoarded.

8.

Perhaps

a family

of

investment-demand

schedules,

one for each

level

of income.

Everyone

will agree

that a change

n the level of income

affects

he

volume

of investment,but

not everyone

will agree that

the level

of

income

is

a

determinant

of net nvestment.

9. See

my Monetary

heory nd

Fiscal

Policy,Chapter5.

The

LM

curve

represents

situation

in which

L

=

M in an equilibrium

sense, L meaning

the demand for money,and

M

the supply

of money.

Similarly

the

IS curve

indicates

a condition

n which

I

=

S

in an equilibrium

sense

(i.e., the multiplier

process has

fully worked

itself

out).



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432

QUARTERLY

JOURNAL OF ECONOMICS

consumptionfunction),

3) the liquidity

preference unction,

nd

(4) the quantity

of

money. The

Keynesiananalysis,

ooked

at as a

whole, nvolvedall of these. But Keynes neverbroughtthemall

together n

a comprehensive

ay to

formulate n integrated

nterest

theory.

He failed to

point out specificallyhat

liquidity

preference

plus the

quantityofmoney can give

us not the

rate of interest,

ut

only an

LM

curve.

It was left

forHicks' to supply us

with the

tools

needed

for comprehensive

nalysis.

ALVIN H. HANSEN.

HARVARD UNIVERSITY

1.

Econometrica,

Volume V, 1937, 147-59.


hansen 1951

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